How I’m Trading This Critical Level In The Market…
The stock market appears to be on the path to recovery. The S&P 500 has now retraced half of its loss.
After a steep decline like the one we’ve had, we can typically expect a retracement — an “up” move that recovers part of the losses. Even as far back as the late 1800s, Charles Dow noted that retracements generally recover 1/3 to 1/2 of the previous decline.
And if you remember back to March 31, I predicted this:
Right now, the stock market is most likely completing a 38.2% retracement of the initial decline. That will bring the SPDR S&P 500 ETF (NYSE: SPY) to about $265, equivalent to about 2,650 in the Index.
Well, as I mentioned, it turns out the market did just that and then some. This is not unexpected, however…
There are a number of reasons for retracements. One is simply the fact that bargain hunters start buying after declines. Another reason is that traders with short positions buy to take profits.
Then there’s the simple fact that, as I mentioned last week, investors are projecting their desires on the market.
Why This Matters For Traders
But here’s why all this matters… Importantly, Charles Dow noted that once a rally retraces more than half the decline, the bear market may be over.
In the chart above, the dashed line shows the 50% retracement level. Now that we are there, it’s time to say the stock market is at a crucial level.
[Related: Support And Resistance: Know Where The Market’s Headed Next]
Breaking higher will offer a “buy” signal to technical traders. That could add to the gains as more money comes off the sidelines. The latest data indicates there is more than $1 trillion on the sidelines in money market funds, which represents significant buying power.
On the other hand, a failure at this level will be a “sell” signal for technical traders.
We need to be prepared for either scenario. That means there is no need to rush into stocks since we can generate income while waiting for a confirmation of the bullish breakout.
There are a number of ways to do this, as folks who are familiar with options well know…
How I’m Trading This Market
One way is by selling put options. This allows us to generate income (in the form of a premium) from stocks (or funds) we wouldn’t mind owning in the worst-case scenario.
In fact, I just recently recommended a trade like this to my Income Trader subscribers with the SPDR Gold Shares (NYSE: GLD) ETF.
As you can see in the chart below, GLD is on an Income Trader Volatility (ITV) “buy” signal. (ITV is the award-winning indicator I developed that we’ve been using since 2013 to make winning income trades better than 90% of the time.)
As you may know, GLD tracks the price of gold. Gold has been volatile in the recent selloff, acting as a source of cash for traders facing market calls. It’s now trading at new highs and likely to hold onto its gains as inflationary concerns mount.
While I recommend selling puts in GLD, I recommend closing the position before the exercise date because I am not certain GLD is the right investment for all readers from a tax perspective.
That said, gold could benefit from the panic gripping markets around the world, as the metal seems to be returning to its role as a safe haven in times of crisis.
As unlikely as it is, an end to the panic could lead to a decline in gold prices. However, gold should do well in the coming days as economic data continues to show the extent of the global economy’s contraction.