Stocks Fell More Than 5% The Last Time This Happened…

This is going to be a relatively quick one. Sometimes there isn’t much to say as the storyline is straight forward. The stock market is primed for profit taking. It’s that simple.

The DOW may have gotten the jump on the other indexes as it started the week in the deep, dark red, down more than 220 points. Meanwhile, the S&P 500 was off by a tiny 0.22% and the NASDAQ jumped nearly 80 points as tech stocks continue to do the bullwork for investors.

But don’t expect the good times to last much longer as the NASDAQ and S&P 500 are in overbought territory. The last time the two indexes had relative strength reading (RSI) above 70, prices fell about 5% in short order. As we type, the NASDAQ is sporting a 75.73 RSI and 76.93 for the S&P. As a rule of thumb, more than 70 is too high (sell) and less than 30 is too low (buy).

As it played out in June, we don’t believe the likely selling to come will last too long. With coronavirus seemingly slowing, fingers crossed and God’s will, most economists believe the economy will continue its recovery and eventually return to its pre-COVID standing.

If prices continue to rise in the near term, investors might consider taking profits on short term trades i.e. selling into strength. Then, if stocks drop as we expect, buying the dip could prove to be a profitable move.

Normally, we would highlight last week’s strongest sector(s) in this space followed by a stock to watch. However, we believe that investors should trade their beliefs. In this case, history and experience say anything we buy today could be cheaper tomorrow. If you see the steamroller coming, why let it flatten your foot? It makes no sense or cents.

In place of the sector/stock ideas, market players who trade for potential in and out profits might consider taking a position in an inverse exchange traded fund (ETF) that goes up when prices go down.

Aggressive types might think about ProShares Short QQQ (PSQ). For every one percent the NASDAQ 100 drops, PSQ should gain one percent on a daily basis. For example, if the NASDAQ 100 drops 2%, then PSQ should add 2%. That makes sense, right?

Really aggressive traders could find ProShares UltraShort QQQ (QID) more to their liking. It too does the opposite of the NASDAQ 100, except it is times two. Using our 2% example above, if the NASDAQ 100 loses 2%, then QID should gain 4%.

Finally, for hyper aggressive, full throttled, 10 monster energy drinks a day traders, ProShares UltraPro Short QQQ (SQQQ) could be the one for you. SQQQ is three to one. If the NASDAQ dips 5%, SQQQ jumps 15%.

Just remember, and this is important, the opposite is true for all inverse ETFs. If the underlying index moves higher, you will lose money. The greater the leverage, the more money you’ll lose if prices climb. Don’t forget.

No matter your level of aggressiveness, inverse ETFs are best used as short-term opportunities because stocks tend to rise over time. If history and experience hold, and RSI scores above 70 lead to profit taking once again, inverse ETFs might provide an opportunity to get in, get out and make a few bucks to offset short term losses in long term holdings.

Rich Meyers