If you watched the boring Super Bowl game on the weekend, you’d have realized that a strong and superior defense can go a long way against a sound offense. But the battle in the trenches was easily won by the defense, and it’s an analogy I use in my trading strategy.
January ended on a sour note, being the first down month since August 2013. With the losses, we are now witnessing an uprising of the bears suggesting 2014 will be a negative year for the stock market. This reasoning is based on the Stock Traders’ Almanac that suggests there is a 46% chance of losses this year. I’m not convinced the stock market is heading lower, but the current stalling and inability of the stock market to move higher is a red flag. Despite an extremely oversold technical condition, I have yet to see any signs of strong buying support emerge—and in my view, this is worrisome and likely means more losses.
The irony in January was that the S&P 500 and Dow Jones Industrial Average actually lost more ground than the higher-risk NASDAQ and Russell 2000, which only lost 1.76% and 2.89%, respectively.
The key will be to watch how the S&P 500 reacts at its key support levels around 1,750 to 1,775. We already saw a bounce off this level, and now the index is staging a retest. As I have said in a recent commentary, failure to hold could see the index fall to 1,700, based on my technical analysis.
The stock market is failing to see any major positive catalyst. Earnings season has been average and the guidance has been mediocre. The economy is moving along, but there continues to be risk, not only domestically, but also globally in Europe, China, and the emerging markets. Europe is facing a potential bout of deflation if it cannot get people spending and driving up inflation from the current 0.7%. Deflation would translate into lower corporate revenue and profits and impact the already fragile jobs market, where the unemployment rate stands near 12%.
With all of this stock market risk, we could see a bigger stock market correction on the horizon, especially should the S&P 500 continue to stall.
So now, just like the Seahawks did in the Super Bowl with their great defense, you also need to be proactive in hedging your assets; consider using put options to form a strong defense against possible further stock market weakness.
In your investment strategy formation, set up a protective hedge if you have not already done so. Of course, you can establish a hedge for a large stock position, or if you are weighted heavily in one, you can form a put hedge in that specific area.
You can easily buy put options for the NASDAQ, Russell 2000, Dow, or S&P 500 to name only a few of many options at your disposal. Examples of popular put options are the PowerShares QQQ (NASDAQ/QQQ) exchange-traded funds (ETFs), SPDR Dow Jones Industrial Average (NYSEArca/DIA), and SPDR S&P 500 (NYSEArca/SPY).
Whatever your strategy, the key is to make sure you are ready in case the stock market continues to weaken.