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Market Alert – at the Line

The ground is shifting for Australian investors. If you’re a regular reader, you’ll know the current stance on market outlook:

  1. The overall economic outlook remains modestly positive, despite significant risks.
  2. Conflicting actions of central banks are likely to bring further increases in share price volatility.
  3. Sentiment is the key to short term market direction.
  4. The market will move broadly sideways in a range between approximately 4,800 and 5,400…
  5. ….until it breaks out by falling through 4,800 or rising through 5,400

And that’s the topic for today. The Australian share price index is approaching the top side of the eleven month trading range.

In a sideways market the rewards go to active investors and good stock pickers. Hence the strategic approach of buying below 4,900 and selling above 5,300. However, despite the market heading toward the upper bound of the range, I’m not a seller.

First, as the market only briefly touched 5,000 on the most recent down-leg, I didn’t buy back enough of the stock I sold into the previous rally. This is the danger of not acting when opportunities present. However, there are stronger reasons for not selling yet, despite the market reaching the “sell zone”.

The events of the last three weeks are illuminating. Brexit, and an Australian election campaign that will once again deliver a senate chamber hostile to the government. Imagine if either of these events had occurred in the first quarter of the year. A fragile market and febrile press may have sparked a real bear market, the kind of sell-off where fear grips investors’ hearts and the share market index halves.

Instead, the market is already bumping the 2016 high. Gains in the face of events that present such obvious potential obstacles can be a sign of underlying strength in a market. The risk right now is that the share market rises rapidly (yes, risk can be positive) and investors are caught with too much cash, thereby missing out on the rewards.

A tactical approach

Choice of tactics at a time of shifting strategy is crucial. The first aim in this approach is to listen to the market – let the price action inform the investment decisions. On the chart below I’ve drawn the ceiling (5,400 - orange line) the 2016 high (5,426 – green line) and the level at which it is more likely the index has resumes trading the range (5,285 – red line).

Highs and lows on charts are important. However, the balance of a market on any given day is expressed at the close. That’s why technical traders want to see a market closing price above or below a given level. In this case, a close above 5,425 would suggest a rally about to start, a close below  5,285 could mean significant further falls.

Until the market does one of the two, I’ m on hold.

Not all will wait. One tactic is to sell all holdings at current levels and buy an amount of index call options at a strike of say 5,450 or 5,500. The amount will depend on the investor, but a neutral position would involve buying call options over a portfolio of similar value to the cash holdings. These give the buyer the right to buy the market index at the strike price. If the market continues to rise the investor benefits. Should the market fall, the investors loses the amount spent on calls, but is able to buy shares at lower levels.

Those without the time or will to discover the power of derivatives for investors may use more straightforward methods – buying or selling shares as the market dictates. Individual investor risk appetites will determine whether this means a turning out the whole portfolio or trimming at the edges. The important aspects at the moment are to listen to the market, and to act when the prices call.

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