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Stock Market Recovery And How To Survive The Fall

02/03/12 09:02:21 AM
by Billy Williams

There are key factors that can help you understand the market's cycle when it crashes as well as how to avoid it and, more important, how to profit by it.

Security:   MA, PCLN
Position:   Hold

On December 7, 2007, a window washer named Alcides Moreno, an Ecuadoran native, fell 500 feet from the upper reaches of a New York City skyscraper -- and survived. By the time he hit the alley behind the black-glass luxury apartment building, he was traveling upward of 124 miles per hour. Moreno worked for City Wide Cleaners and was getting ready to wash windows when the cables for the scaffolding snapped.

He did not get up and run back to his spot at the top of the building and immediately get back to work, since he wasn't wearing a safety harness at the time of the fall. He broke both legs and his right arm, with a total of 10 bones broken in all.

The same could be expected from the stock market after a massive crash or correction, where it does not just jump back up and begin its ascent right away. While it has a long-term history of going upward, the damage done to both price and the psychology of the traders that make up the market require a measure of healing and repair.

In trading, success is measured by the safety tools that you have in your trading arsenal, including statistical facts to be used in conjunction with a sound approach to the market. In the case of a stock market crash, a few key facts can help you avoid being on the wrong side of the market when its underlying dynamics might be susceptible to a crash, allowing you to walk away to trade another day.

First, what is the most bearish period during the calendar year for the stock market? August, September, and October are the most bearish months during any given year on a statistical basis. During this period, prices are likely to drift lower with the potential of a total collapse as most crashes are attributed to October. See Figure 1.

FIGURE 1: MA. In the crash of 2008 during October, Mastercard, a high-performing stock at the time, was crushed by the massive selling wave that overcame the market at the time but managed to rise higher near the extreme price lows set during that key month.
Graphic provided by:
So what is the most bearish month during the year? If you said October, then you fell into a trap, because while most crashes are credited to that month, the fact is that September suffers the greatest price decline. However, capitulation on the part of both price and traders in October is a consequence of September's steep decline, resulting in most of the stock market's historical crashes (1907, 1927, 1987, 1997, 2002, 2008, and so on).

That said, October is a great indicator of future bull runs, since selling climaxes are synonymous with this month, when extreme price lows are hit, followed by a rally.

Once you know these facts, market crashes are seen not so much as a thing to be avoided but as an opportunity for an astute trader who is well-versed in stock market history with a frame of reference on how cycles play out. When market weakness is entering en masse, September now becomes the target month for shorts, with October both signaling a time to exit as fear hits its zenith at deep price levels and a time to strategically buy into it as well. See Figure 2.

FIGURE 2: PCLN. Priceline, a stock leader at the time of the 2008 crash resulting from the US housing crisis, was taken down to an extreme price low during October at the zenith of the stock market decline, followed by a bullish recovery as the stock traded back to its former highs and emerged as a stock leader once again.
Graphic provided by:
The strongest stocks will resist the decline but will be affected. However, they will offer higher levels of value as the market begins to emerge from the shock and work its way to its former highs. Buying index options are another way to exploit the recovery that is likely to follow by utilizing the high leverage of options while enjoying the limited risk of the price of the option itself.

It is these critical moments in the stock market where fortunes are made, but you have to be strong of heart with a willingness to act when others are sprinting in the opposite direction.

Billy Williams

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

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