Fire Sale of Stocks Could Get Bigger

The fear now is the occurrence of another recession in the U.S. and globally. Could the downgrades be enough to trigger another sell-off and financial collapse?This is not a market for the risk-adverse. Watching the key stock indices plummet over 10% in less than a week is scary and nerve-wracking.

But the world is not ending. That I can say.

My best investment advice at this time is to remain calm, but at the same time monitor your positions carefully. Use put options to hedge the downside risk.

The Standard & Poor’s downgrade of the U.S. credit to AA-plus from triple-A is worrisome, as the country may have to increase its risk-adjusted yields to attract buyers of debt. This in turn would place an extra burden on the U.S. treasury and continue to make it difficult to deal with the massive debt and deficit. The S&P 500 is also looking at another potential downgrade to AA in November. The rating agency is also looking at U.S. local and state governments with exposure to these debts. I like the decision to downgrade, as it is objective.

While there is a risk of another recession, the likelihood is low at this point, but could pick up if the U.S. economy falters. JP Morgan Chase & Co (NYSE/JP) downgraded its estimate for the U.S. Q3 GDP to 1.5% from 2.5%.

At this juncture, the near-term upside potential appears to be limited unless there are new reasons that entice traders to buy.

The key risks are:

1) U.S. economic renewal

2) U.S. debt and deficit

3) European debt and growth

4) Global economic growth

The fear now is the occurrence of another recession in the U.S. and globally. The concern is that the downgrades could be enough to trigger another sell-off and financial collapse.

The bear market is in effect. The stock charts are extremely ominous and there is a lack of sustained buying support, as the selling bias grips the market.

Investor sentiment is extremely bearish.

The DOW lost a whopping 512 points or over four percent on August 4. But this was followed by a 634 point sell-off, or 5.55%, on Monday, the worst one-day loss for the DOW since December 2008.

Technology fared the worst, with the NASDAQ plummeting over five percent on August 4, followed by a 6.9% decline on Monday.

The selling capitulation has entrenched the market, as investors and traders continue to head for the exits. The selling volume is high and on the rise, which is bearish.

Charts are bearish and flashing a SELL.

The near-term technical picture is bearish, as the key stock indices trade below their respective 50-day and 200-day moving averages.

In addition, Dow Theory also indicates a reversal to sell based on the Dow Jones Industrial Average and Dow Jones Transportation Average both breaching their respective June lows on August 2. Again, this is not a good situation.

The S&P 500, NASDAQ, DOW, and Russell 2000 are deep in negative territory for this year.

The biggest losers are the small-caps, with the Russell 2000 down over 17% this year.

The key stock indices are down over 16% from the high, which is technically a market correction. The Russell 2000 is down a whopping 25.12% from its high as of August 8.

U.S. stocks are now underperforming the Shanghai Composite Index.

The stock market is dangerous at this time in the absence of a base or support. The condition is extremely oversold, so watch for any support. Failure to hold could drive the stock indices to new multi-year lows, so be careful.

The best strategy for risk-adverse traders is to protect via put options.

My best stock advice is to wait and see for some strong support on high volume prior to buying.

Be careful and remember that maintaining your capital will allow you to trade longer-term.