The market just seems to want to go higher. In fact, we just hit yet another record high on the S&P 500, as buyers continue to default to broad market domestic equities as the place to get their returns. Yet, when things get too exuberant, I start to get a little worried -- especially this time of year.
The theory here relies on historical trends that show May tends to be a relative weak month for stocks, while June has historically been a down month for equities over the past five decades.
A few years ago, I did some research on the sell in May strategy using the "Stock Trader's Almanac." What I determined was that if you went long the market on Nov. 1, 1972, and then spent the next 37 years (through 2009) selling on April 30, and then rebuying on Nov. 1 and holding until April 30, your average annual return would have been 7.4%. If, however, you would have done the reverse, buying on April 30 and selling on Nov. 1, your average annual return would have been just 0.4%.
Now, this historical analysis should not serve as a trading strategy in any given year; however, I bring the issue up because the sell in May strategy will be in the news soon, and if other factors also line up to put pressure on stocks, then you'll want to be prepared to take advantage of any rapid sell-off.
One of those factors that could soon be pressuring stocks is a contraction in ETF assets. According to Asbury Research (a firm I find extremely prescient when it comes to spotting market trends), the total daily assets invested in the SPDR S&P 500 (NYSE: SPY) fell below its 21-day (monthly) moving average on March 28 and March 31.
Asbury points out that the past two sustained moves in the metric below the 21-day average actually coincided with corrective declines in SPY during August and September 2013, and most recently, between Jan. 17 and Feb. 13.
Based on these two recent historical pullbacks, Asbury concludes that the domestic broad market index is once again vulnerable to beginning a pullback over the next few sessions.
More importantly, Asbury wrote that, "If these assets continue to contract, and remain below their monthly moving average, a correction will begin soon in the US broad market index."
The way I see it, the contraction in SPY could be an early warning sign of further downside in the markets, downside that also could be triggered by a host of fundamental, geopolitical or other exogenous events. And, with the sell in May bias just around the corner, we could be setting ourselves up for a short-term dose of bearishness.
As traders, one way to take advantage of that is with the ProShares UltraShort S&P 500 (NYSE: SDS). This fund is designed to deliver twice the inverse performance of the S&P 500, so if the benchmark index were to drop 5% in May on a confluence of bearish factors, then SDS should rise 10%.
Finally, while the SDS trade is one that I think traders can capitalize on, I don't think you should jump in headlong right now. In fact, I am watching and waiting to see if the contraction in daily assets invested in SPY can actually push the index lower this time.
If it does, then I would like to see SPY fall below its 50-day moving average. That would give me confidence that a sell-off is, in fact, in place -- and that would be the time to buy SDS.
Action to Take -->
-- Buy SDS if SPY falls below its 50-day moving average
-- Set stop-loss approximately 10% below entry price
-- Set initial price target 10% to 15% above entry price
This article was originally published at ProfitableTrading.com:
Get a Head Start on Sell in May and Go Away With This Fund