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Time to Take a Swing on the Market

Sometimes the market rewards a methodical approach to finding well-calculated, high-odds trades. However, this isn’t one of those times. This is an environment where the market stops and starts on a dime, and you’ve got to be forward-thinking - and willing to stick your neck out a little - if you want a shot at making any money. With that as our backdrop, we’ve got a trading idea for you today.

The flipside of this more aggressive strategy is a tighter target and stop plan. Since the odds of a major, prolonged move right now are slim, we’re not going to bother trying to squeeze something unrealistic out of a chart - we’ll use a smaller-than-average target. Likewise, since the reward is reeled in, we’ll proportionally reel in the risk.

Here’s the deal - we like the market’s upside potential from current levels. Had it not been for Monday’s disastrous selloff, the S&P 500 would have made eight consecutive higher closes. Granted, that big pullback wiped away the bulk of the gain over the previous five trading days, but look at how well (and how quickly) the market recovered after Monday’s dip. We’re just seeing enough persistent buying interest - after hitting new multi-year lows a couple of weeks ago - that we feel a swing on an upside trade is merited.

Risk? Yeah, there’s plenty of that too, though the potential reward makes it worth it. Nevertheless, this erratic market could still do anything at any time. So, we’re going to keep a short leash on things and use a real tight stop.

Make sense? Great. Keep reading for the trade’s specifics.

Getting Into The Game

The focal point for the trade is the S&P 500. But, since you can’t actually trade an index, we’re going to suggest a couple of different ways to take advantage of the idea. The first one is a leveraged ETF (exchange-traded fund), while the second one is an ordinary ETF with a little more possible ‘umph’ right now than the broad market might have.

So why bother talking about the index at all if we’re trading an ETF? Because our target and stop - and the reason we’re interested at all - are based on the index. We could probably do a comparable analysis with an exchange-traded fund, but frankly, even an index ETF can get a little ’squirrelly’ sometimes and be more volatile than its represented market index. Rather than get whipped around or stopped out by an ETF’s wild movement, we’ll just use the index as our basis.

Long story made short, we think the S&P 500 could move up to roughly 957. That’s where the first big Fibonacci retracement line of Q3’s selloff is resting. That level was also support as well as resistance a handful of times in October and November. If-and-when the SPX gets to 957, we’ll consider that an achieved profit objective, and we’d advise getting out of the trade then.

On the flipside, we think 790 would be a good line in the sand to use as a stop. If you go back to the 24th of November, you’ll see a low of 801.20 … which also happens to be the high from the prior trading day. Is it a gap? Technically no, but functionally, yeah it’s a gap.

More pertinent to us, since gaps have a way of imposing gravity on the market, we want to give the index enough of a berth to close the gap - if it’s in the cards - without being taken out of our trade. So, we’ll suggest a level of 790 as a decent stop level for the SPX.

If you look closely at the chart and the numbers we cited above, you’ll see the reward potential is only about 10%. Not a lot? It depends. Bear in mind the kind of environment we’re in. A year ago we may not have even bothered shooting for a 10% gain. This year though, capturing a 10% move is like winning the lottery.

Still, we’re looking for the most bang for our buck. That’s why we’re going to suggest using the ProShares Ultra S&P 500 ETF (NYSE: SSO). This fund moves in tandem with the S&P 500 Index. However, it moves by twice as much… if the market gains 10%, the fund is designed to gain 20% (and if the market falls, it falls by twice as much too). That’s why we like these ETFs so much - lots of leverage. Well, that and the fact that they trade just like stocks.

Anyway, though we’ll be watching the S&P 500 for target and stop purposes, we’ll actually be trading SSO.

If you’re not interested in 2-to-1 leverage, the familiar S&P 500 Depository Receipts (AMEX: SPY) are built to perfectly mirror the market’s overall return, for better or worse. However, if you’re going to go the 1-to-1 route, you may want think about the iShares Russell 2000 Small Cap ETF (NYSE: IWM) instead. You might find a little more net movement there right now than you would with SPY. Just a thought. We’ll be tracking the SSOs for our official trade though.

Speaking of exchange-traded-funds…

Long-Term Value Idea - Financials

Let’s face it - 2008 is going to go down as a terrible year, even if December is stellar. You know what though? There’s actually a huge opportunity in all this mess for those investors who aren’t fixating on any and all reasons why they should steer clear of stocks … forever.

The fact is, there are some darn good values out there, particularly in the financial sector. I know, I know … the fundamentals stink right now for the group, and the foreseeable outlook ain’t much better. I get it.

By the same token though, as far as financial stocks are concerned I think the vast majority of the pain is behind us. This sector’s combined market value was reduced by 55% over the last twelve months. So, these stocks literally can’t lose more than they already have. Frankly though, I don’t think they’re going to lose anywhere close to that amount - I think the worst is almost over, if not completely over already.

Now, I’m under no illusion that the rebuilding of the financials won’t take a while, which is why I’m putting this out there as a long-term idea … as in years. The group may well be lower 3 to 6 months from now. However, I think they’ll be much higher 3 to 6 years from now.

The best way to take advantage of this kind of sector-wide expectation is with a sector-based ETF, since individual company stocks are still a bit of a coin toss. The industry as a whole though should come out of this train wreck as an even stronger group. The Financial Select SPDR ETF (NYSE: XLF) is the most direct way to start wading into the sector.

We’re not going to add XLF as an official trade today, though we may well do it in the future when we have time and room. I just wanted to put the idea on the table for now as something I think you should seriously consider as a long-term holding. I know it may be tough to do in the midst of a rather large mess, but it’s not like money and finances are ever going to be removed from our culture - it’s what makes the world go around.

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