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Get Ready for Next Bear Leg and Start Hedging

Published on March 27, 2009

Get Ready for Next Bear Leg and Start Hedging

March 27, 2009

As of yesterday’s close, the DJIA has gained 21% since establishing the March 9 low. The S&P 500 and NASDAQ have gained 23% and 25%, respectively, over the same time period. Wow, we have had wonderful rally so far, >20% gains in matter of less than 3 weeks; and probably one of the strongest rally that we have seen in this bear market. To make the bullish case even stronger, the rally continues to extend despite overbought conditions showing solid strength.

dow-great-depression-pix-1But, is this short covering or real buying? During great depression, there were almost 8 to 9 rallies depending upon what you consider rally. Market topped out on Sept 3, 1929 @ 386.10 and then it dropped 18% fairly quickly (almost 1 month) and recouped 50% of losses in few sessions. Then it dropped again from 358 to 212 i.e. (60%) in about a month’s time (Mid Oct’29 to Mid Nov’29) and it recouped slightly less than 50% of this fall in next few weeks then there was another correction before indices marched upward to regain 50% of losses from all the way from Sept’29 top. The rally continued till Mid April’30. There so many sharp snap back rallies till Jul 8,32 when Dow bottomed at 40.60 never to see that level again.

In the current scenario, from a 14,198 top to Mar 9 low 6470 for Dow,  the 50% target will be around 10,334. So there is all likelihood for indices to go those sort of levels in extreme cases before resuming any downward trend assuming the economy continue to deteriorate. But before Dow even touches 50% level, there will be minor resistance at 8,000 followed by strong 8,900-9000 band.

The crux of the matter is “Ignore the past and you will lose one of your eye, and live in the past, you will lose both”. If history is a good indication, then intermediate basis, this bull has leg to more before falling hard but is extremely overbought on short term basis. Contradiction?

What to do? If you have enjoyed nice gains, it’s time to either book half gains and hedge remaining half or hedge fully. Consider hedging as an insurance against a possible storm that may arrive without any notice. If you are using OPN type strategies, the insurance will be well paid-off by the portfolio gains. But I personally will suggest caution here and start hedging your portfolio gains.

I shall later discuss general strategies for hedging your portfolio. But that post will be available for members only. (You may want to sign-up for the Basic Membership (Free until Dec 2009) that I use to share free trade alerts for registered members).

Have fun and profitable trading, OP

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