I hope you had a happy holiday season, but unfortunately, I have some news that may dampen your spirits.
(But if you stick with me through the end, I promise to send you on your merry way with some good news…)
The chart below summarizes the state of the stock market.
As I write this, the S&P 500 now stands at 2,351.10 — officially 20% below the all-time high it set back in September. It is also more than 14% below its 200-day moving average ( MA ), which is shown as the solid line in the price window. Prices have fallen quickly, and the question is now whether we should expect a bounce higher in the short term.
PAM Predicts Short-Term Reversal Coming Soon
My Profit Amplifier Momentum ( PAM ) indicator spiked lower at the end of last week. The spike is clearly visible in the weekly chart below, with PAM shown in the bottom panel.
PAM, like other momentum indicators, tends to reverse after a very sharp move in either direction, and rapid declines in the value of the indicator are almost always followed by a short bounce. Based on this trend, I expect we’ll see this kind of temporary bounce in stocks in the next week or so.
The next chart confirms my outlook for a short-term bounce. This chart shows just 14.3% of the stocks in the S&P 500 are trading above their 200-day MA. Almost 85% of the members of the index are below that MA.
We haven’t seen a reading this low since January 2016… which was followed by a 7% rally over the next two weeks. We saw a similar low in the indicator in August 2015, which was followed by a three-week gain of 8%. And before that, a low in August 2011 was followed by a three-week gain of 12%.
Now, it’s important to know that a bounce should not be confused for a fresh rally… the upward movement is almost always short lived. In fact, each of the three rallies I just mentioned was followed by another selloff — and there’s no reason we should expect this time to be any different.
Potential IWM Bounce Could Net 100% Gain
…However, this pattern set up a short-term trading opportunity that I alerted my Profit Amplifier readers to a few days ago.
The iShares Russell 2000 ETF (NYSE: IWM ) is the most oversold index ETF right now. Aggressive traders could consider buying call options on IWM, which will go up in price if IWM’s price rises.
Recently, the IWM Jan-4 $128 Calls were trading at about $3. (That’s a call option on IWM with a strike price of $128 that expires on January 4, 2019.) Since a contract covers 100 shares, the trade would cost $300 to open. That is also the maximum possible loss. (When buying a call, the trader can only lose the amount paid for the call. The loss is limited and can never be more than that.)
Assuming history repeats itself and stocks rally at least 7% off these oversold extremes, these calls could potentially climb to more than $6, for a short-term gain of 100% or more.
Remember, I recommended this trade several days ago, so it may not be practical to make this exact trade by the time you read this. That said, you could look into making a similar trade like this. You should only enter this trade if you feel comfortable managing options on your own and it fits your risk profile.
Fed Forecast Confirms My Recession Fears
Longer term, I expect more downside. The Federal Reserve meeting confirmed my fears that a recession is likely to emerge next year.
The Fed told investors to expect two rate hikes in 2019. That’s down from the three rate hikes that investors were expecting three months ago. If the Fed expected strong growth in 2019, they would have maintained their forecast for three hikes.
The Fed also lowered expectations for GDP, which is most likely the reason they changed their interest rate forecast. Slower growth means there is no need for higher rates to keep the economy from overheating.
Fed Chairman Jerome Powell also noted “some crosscurrents have emerged” in the economy, which worried many traders. This was an acknowledgement that trade policy, a government shutdown, and other factors are affecting the pace of growth.
A slow economy could easily tip into recession if one of the many crosscurrents Powell noted spirals slightly out of control. Bear markets associated with recessions see an average loss of almost 40% in the S&P 500. I believe that’s a realistic expectation for the bear market that is now officially underway.
Now, I told you I would end our 2018 with some good news, and here it is: Just because we’re likely looking at a falling stock market doesn’t mean our portfolios need to suffer the same fate. A down market will still present a number of short-term trading opportunities. In fact, my Profit Amplifier subscribers and I have already made a handful of 100%-plus gains in the past five weeks .
No matter what happens on Wall Street — or in Washington — I expect 2019 to be a profitable year for us. That’s why if you haven’t taken the time to learn more about our strategy and how it works, I strongly urge you to do so now. You can follow this link to learn more now .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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