6 Signs Of A Correction

 |  Includes: DIA, IWM, SPY
by: Tony Pow


The market is risky.

Signs of a correction.

How to prepare yourself for a correction.

The best protection is playing defense now. The chance of a correction (10% or more) is high.

Six signs of a correction

1. All my technical indicators show the market is peaking and overbought. SPY is an ETF simulating the market of S&P 500 stocks. As of 6/29/2014, the RSI(14) is 67% and the SMA-200% is 8.35%. SMA-200% measures how far away the stock price is from its simple moving average of the last 200 trade sessions.

You may argue that you do not believe in technical analysis. However, most institutional fund managers learn technical analysis and they will act accordingly. Most mutual fund managers cannot practice market timing bound by the rules and regulations.

2. Newton's Law of Gravity has never been proven wrong. What goes up must come down. The market is up even after inflation. However, it takes a breather from time to time. A small one is called a correction and a big one is called a market plunge.

3. We did not have one such correction of 10% in 2013, so the time is ripe. The average is about one correction of 10% or more for a year. Many experts predicted wrongly on a correction in 2013. I do not bet against them to be wrong two times in a row.

4. There are more articles predicting a correction than articles arguing against it. It could be a self-fulfilling prophesy. It is the herd psychology.

5. Today's low volume may indicate that the market is changing direction. The sea is calmest before a storm.

6. I am not convinced that I can make a lot of profit even if there is no correction. To me, the market is fully valued. It is my reward / risk ratio. I prefer not to make the last buck and have a good sleep.

How to protect yourself

It depends on your risk tolerance.

1. Accumulate cash from 0% to 50%. I recommend 15% for most. 0% is for those who ignore the signs. It was a great selection for 2013. I select 50% as I'm more conservative than most.

2. Place stop orders. Adjust them when they appreciate. Some stocks are more volatile than others. I prefer to use stop orders in market plunges than corrections as corrections are too brief to be effective.

3. Short the market. I do not recommend shorting in most cases. Buying a contra ETF may help. In any case, do not gamble money you cannot afford to lose.

4. Prepare a list of stocks to buy when there is a correction.

What if there is no correction

Do not treat my (or all others') predictions as gospel. Predictions are just predictions. It is like buying insurance that we do not expect to collect.

I have to admit market timing is not an exact science. Hopefully we are more right than wrong. However there is no guarantee for future predictions.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.