Surviving a September plunge

SEPTEMBER is the meanest month in the market, usually ending lower than when the month starts. October often includes the final section of the September plunge, but the market usually finishes higher at the end of the month.

This makes for a very high probability of a market retreat in September. Experienced traders like Kathy Lien in the US suggest that Wall Street’s record-breaking run just hit a wall. She cites rising jobless claims and hot producer inflation. All of this adds up to a margin squeeze, which would magnify the impact of any market retreat.

This highlights the key question for traders and investors. How does one distinguish between a stumble followed by a recovery, and a more serious market fall or collapse?

We can choose our favourite market commentators, or find an analyst who confirms our opinions. Some have been forecasting doom for months, while others have seen nothing but endless blue sky, with the major US indices rising to death-defying heights.

The usual September market performance behoves us to carefully watch the behaviour of any market retreat. What evidence would suggest that a retreat is a temporary blip in the long-term rising trend?

If the retreat is just a blip, then it provides the ideal opportunity to add to existing investments at a cheaper price before the market rebound. If a retreat is the beginning of a trend collapse, then we need to move quickly to protect profits. That means selling or developing effective hedging strategies using derivatives.

As Lien suggests, a margin squeeze where traders are forced to sell to meet margin requirements can trigger a significant market collapse.

Assessing retreat or collapse

The key to assessing a retreat or collapse is to identify the support levels or support features for the index or commodity. A fall to support followed by a rebound is a buy opportunity.

A fall below support increases the potential for a trend change. This potential is increased if the market behaviour takes place within the context of an end-of-trend chart pattern.

On the Nasdaq chart, there are four features of significance. The first is the long-term support level A, as reflected in the graphic, near 22,345. This is the first “bounce” level for any market stumble and rebound.

The second support feature is provided by the value of the long-term uptrend line B. The current value of this trend line is 22,035. A market fall to the region between the first and second support levels would be consistent with a stumble-and-recovery situation. The role of trend line B is the critical divider between a stumble and a fall.

A move below trend line B has the third level of support near 20,352 and line C. A fall to this level could be followed by a rapid rebound, similar to that seen in April.

The danger is that a fall to support level C could be the start of a significant downtrend. It takes brave traders to bet on a repeat of the April rebound behaviour.

The fourth feature is the resistance level near 24,360; this is important as it may provide a barrier to further rises in the Nasdaq for a stumble and rebound from 22,345.

Currently, there is no indication of any end-of-uptrend pattern developing. This includes patterns such as rounding tops, double tops and other trend-exhaustion behaviours. This suggests that any retreats are likely to be temporary, offering opportunities to add to existing positions at bargain prices before the uptrend resumes.

Shift to gold

If investors think there is a significant increase in risk, then we expect to see a shift to safe assets such as gold. The gold price has consolidated on the weekly chart and appears to have difficulty breaking above resistance near US$3,500 per ounce.

This is a significant resistance feature, but of more significance is the short-term uptrend line B. This creates a bullish upward-sloping triangle pattern that started in April.

The baseline or height of this pattern is projected upwards above US$3,500. This price projection sets an upside target near US$3,964.

The gold price has edged above the resistance level, so there is an increased probability that this breakout will continue. This is consistent with the long-term uptrend shown by trend line A.

The very hint of a breakout and the bullish upsloping triangle suggest a steady investment shift into this safe asset. The breakout could fail, and gold could fall 12 per cent to the value of trend line A near US$3,085 and still remain consistent with the long-term uptrend.

It is notable that this 12 per cent separation between the trend lines A and B has been consistent over five months.

Surviving the September plunge needs a better strategy than to hold and hope. Support features suggest when it’s time to let go, or join the bounce recovery.

The writer is a financial technical analysis specialist, equity and derivatives trader, as well as author, and has an open position in a gold exchange-traded fund