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August Rundown And Strategy

07/29/11 08:42:58 AM
by Billy Williams

July's weakness may carry over into August, but will it cause a decline or signal a rally into the end of 2011?

Security:   SPX
Position:   Sell

While I agree that for the healthy individual, looking forward to a bright future instead of gazing intently on the past is a building block for a happy life, I take the opposite view for a trained speculator. Past price action may not indicate future price action, but it's the strongest indicator available. Why? Because markets are made of human beings with all the blessings and weaknesses inherent to that condition, and price action is the result of those characteristics expressed in the market.

That being the case, if there is a rally at one point, then as sure as night follows day, there is also a correction or decline as well. For the month of August, corrections in the markets tend to be smaller than any price rally, where every bounce outdoes the average pullback. However, the average gain is smallest between the summer and autumn, which makes trading from here till November a bit tenuous.

The mild pullbacks signaled by August are typically a matter of portfolio restructuring brought on by individuals selling off nonperforming stocks to register a tax loss and the major institutions themselves who want to get rid of their losing positions before preparing year-end statements.

The month of October, in particular, is a source of anxiety because trading can be touch and go beginning in August, with October a source of anxiety for veteran traders who connect this month with one of massive crashes, such as 1929 and in 1987 to the present. See Figure 1.

FIGURE 1: S&P 500.Earlier in 2011, SPX looked as if it was ready to push higher as it formed an inverse head & shoulders pattern, but May heralded in a decline and broke the pattern where it was itself still in a trading range. Now, as July ends and August begins, recent price weakness combined with seasonal price corrections could see the SPX take another leg downward.
Graphic provided by:
Since 1964, according to the 2011 Stock Trader's Almanac, there have been 17 autumn declines of over 10%, and in 10 of them (1966, 1974, 1978, 1979, 1987, 1990, 1997, 2000, 2002, and 2008) with major damage done in October, where so many bear markets end. Recent October lows were also seen in 1998, 1999, 2004, and 2005. Most often, it has paid to buy after fourth-quarter or late third-quarter "waterfall declines" for a rally that may continue into January or even beyond.

All were Black Swan events that no one had foreseen, and in the case of trading during this time, remember, discretion is the better part of valor, so remain cautious.

So how do you make money during August?

As July ends on weakness, it is likely that this weakness will carry over into August, if only at the beginning. This means that you must find the weakest stocks in the herd and prepare to short them mercilessly while retaining a hit list of stocks trading near their all-time highs possessed of high relative strength if the market turns.

Having a split combination of short and long candidates can allow you to begin hedging your portfolio and take advantage of both the weakest segments of the market as well as the strongest segments of the markets.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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Comments or Questions? Article Usefulness
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Date: 07/29/11Rank: Comment: He wrote two articles on 7/28 and 7/29. They appear to give opposite opinions. Should one hold or sell SPX?
Date: 07/29/11Rank: Comment: He wrote two articles on 7/28 and 7/29. They appear to give opposite opinions. Should one hold or sell SPX?

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