ACTV - We're Not Shorting This Market But If You Must Now's The Time

2023-06-08 03:05:34 ET

Summary

• We think 4,300 on the S&P 500 is a magic moment. It presents a low-risk shorting opportunity for those who disagree with sentiment and expect another decline.
• Every trade starts with a negative, not a positive. You want to define when a trade, or the idea behind the trade, is wrong with the least amount of loss.
• History has shown that investors don’t have to worry about a major downturn until investor sentiment reaches higher levels of bullish sentiment. Indicators show we’re not there yet.

We've written several times ( here and here ) that we think the S&P 500 is going to go to 4,800, so we, as intermediate to long term investors, don't recommend shorting the market at this time.

However, investing is a game of odds. You act on your best judgment with full knowledge that one can be wrong, and you adjust your strategy accordingly. Why do we believe the market's going to 4800 and that it's not a good for us to short the market now? Investor Sentiment.

Investor sentiment is why we think it's not a good time to short the market

We think investor sentiment is the best indicator of market tops and bottoms and whether a rally will continue. At the Sentiment King we calculate daily our master sentiment indicator called the ST-MSI, which is composed of seven, well stablished sentiment indicators. Using a composite improves reliability and keeps us from reaching our opinion with just one metric. It's shown below.

The arrows point to periods last year when sentiment reached extreme levels of bearishness. It was these extreme readings, plus our belief in the importance of sentiment, that kept us bullish throughout the second half of last year. It's also guiding us now.

History has shown that investors don't have to worry about a major downturn until investor sentiment reaches higher levels of bullish sentiment (the red zone). The indicator clearly shows we're not there yet. There are just too many disbelievers in this rally. Of course, anything is possible. We're just saying that current levels of investor sentiment make it highly unlikely.

But, how about those investors who think other factors are more important than sentiment? If a person thinks the market is going to decline again soon and is looking for "when" the decline will start, it's our opinion they should act now. Why? Because the risk versus reward equation of a bear trade at this moment is highly favorable, no matter what sentiment says.

A low risk-high reward short trade if you're bearish

Every trade starts with a negative, not a positive. You always want to define when a trade, or the idea behind the trade, is wrong with the least amount of price loss. It's contained under the maxim, "cutting losses short." It's also based on the old maxim, "Profits take care of themselves, losses never do." So you plan ahead for the worst.

Ideally, even though it's impossible, you want a trade that can make you 20% if you're right but give you a small, 1% loss if you're wrong. To have any possibility of doing that requires that you be at an apex moment. An apex moment is a moment that allows you to do this within the framework of your investment method. I think 4,300 on the S&P 500 is just such a moment as I explained in this February 5th article .

The chart above is taken from the February 5th article. It diagramed what I thought the market would do if it didn't reach 4800 on the S&P 500 (In the article I used the SPY as a proxy for the S&P 500). There is no need to update the chart here since it's on target.

The chart showed prices reaching 4,300, and then turning down into a major declining wave. This was the alternate scenario I created if prices didn't reach 4,800. In my mind it was either 4,300 or 4,800, nothing in between.

We've reach the vicinity of 4,300 since the S&P 500 is currently at 4,266 as this is written. Now, the question is, will it roll over and start down into a second declining wave toward C, as was diagrammed in the alternate scenario?

The short trade is simple

The short trade is based on the market being at the apex point of 4,300 on the S&P 500. The trade could last a day, or six months. If the market breaks above 4,300 and reaches 4,343 (1%), you take your loss. The trade assumes that if it breaks through then it won't decline. However, if prices hold and start to move down, you don't sell and take a profit but hold the position expecting a four to six month decline, and an ultimate profit of 20%. That's the key behind the trade - it's short term on the sell stop, long term if it moves down.

I'll leave the investment vehicle to short the market up to you. It can be a number of investments - a ProShares short fund, a put option on an index, or even shorting S&P futures contracts. The critical points is to sell the investment at a loss if the S&P 500 reaches 4,343 and do nothing is prices roll over start down. The trade will take care of itself.

If market sentiment were extremely bullish right now, I would make this trade, but it's not, so I won't. For those traders who don't believe as strongly as I do in market sentiment, in my opinion this moment represents a unique trading opportunity. all other factors considered.

For further details see: