IXIC Overvaluation Analysis and Subsequent Hedging Strategy
This is a bit late, but I wrote it on 2/25. Perhaps it will still be helpful.
*Background: To prevent repetition: all analysis presented is based on the monthly view of IXIC and all data given will be therefore based on that chart unless otherwise specified.
Prior to the 2000 “Dotcom Crash”, the IXIC had a brief correction of roughly 20% lasting roughly 92 days or 3 bars. After this correction the IXIC rallied in a spectacular bull market gaining 220% in valuation over a period of roughly 547 days or 18 bars. After this subsequent peak, during the 2000 “Dotcom Crash,” the value of IXIC initially corrected its valuation by 27.8% over 61 days or 2 bars. Immediately prior to this valuation correction, the RSI rose 73% to a peak value of 85.5. The IXIC then stabilized, as is supported by the RSI stabilization, and it can be reasonably assumed that this temporary stabilization is due to adequate volume support (the reports of which are unavailable), for a further 151 days or 5 bars. Then the IXIC further corrected its valuation 65%+ over 732 days or 24 bars, which was accompanied by a drop in RSI to a low of 33.
Our current bull run has been similarly preceded by a relatively minor and short lived correction related to the economic impact of SARS-CoV-19. This “Covid Correction” has been followed by a IXIC valuation increase of 76% from the bottom of the previous correction. Based on this most reasonably similar event, the 2000 "Dotcom Crash," the current IXIC market has a further upside potential of between 45% if the final valuation increase is 150%, 65% if the final valuation increase is 200%, and 80% if the final valuation increase is 230%, based on overall IXIC valuation. Based on the same comparison between the peak of the RSI prior to the initial correction in 1999, the IXIC has a further RSI upside of roughly 11% to 85 from its current value of 76.
Based on valuation and current IXIC trends there are possible tops around 6/21 with a 19450 IXIC valuation (150% final market valuation increase or MVI); 9/21 with possible IXIC valuations of 19587 and 22283 (150-200% final MVI); 1/22 with a possible IXIC valuation of 22283 (200% final MVI). On the outside, with a final MVI of 230%, we see possible tops at 11/21, and 4/22 with a 24300 market valuation. It seems unlikely that because of the proximity of the RSI to peak RSI values (11%) that a further 80% market valuation will occur. The key deciding factor in the final IXIC valuation, I believe, will be the timing of the peak RSI of 85 with the current IXIC market valuation. It seems reasonable to act on an RSI of 85 given current market conditions and past corrections occurring with an RSI of 85.
Theory: when peak market valuations are met with a peak RSI of 86.28, which represents a 13% increase from current RSI of 74.89, the market will be compelled to revise the valuation of the tech sector specifically. This RSI/market valuation link seems, based on past corrections, to be key. If the IXIC reaches valuations stated above without correlating RSI values of 85+, the chance of a major market correction is lower as a correction without an RSI of 85+ is unsupported by past examples. Based on previous samples (the 2000 "Dotcom Crash," the 2008 "Housing Market Bubble," and the 2018 "Banking Crisis"), the initial downside potential is at or around 30-40% with SPX and DJI following the downside trend and momentum with similar results. This initial correction will most likely take place over a range of 45-90 trading sessions or 2-6 months.
After the initial market correction, the bulls will most likely step in and secure a volume support which will sustain the market in a flat trajectory for a likely period of 6 to 8 weeks, after which there could be further downside potential based on the market valuation at the peak of the valuation prior to the initial correction. A further hypothetical correction based on the 2000 crash has the potential to bring the total IXIC correction to 70%, however unlikely. A more likely scenario is a further correction of 30% followed by a volume support stabilization taking place over a time frame of up to 2 years. These corrections, after the 1999 crash, took 13 years to be reclaimed after their final bottom. This brings the total event to roughly 15 years. The 13 years following the 2000 correction traded as a modest bull market which would present opportunities to earn back some lost capital.
Keys: Watch for large downside market movements at: -6/21 with a market valuation of 19450 and RSI of 85+ -9/21 with a market valuation between 19450 and 22283 and an RSI of 85+ -11/21 with a market valuation of 24300 and an RSI of 85+ -1/22 with a market valuation at 22283 and an RSI of 85+ -4/22 with a market valuation of 24300 and an RSI of 85+ -**RSI is historically a key metric**
Strategy: -Hedge all positions with a maximum loss goal of 10% over the entire course of the correction ->Hedging strategy can consist of a buy/write covered call strategy while purchasing a put against the held shares with a net credit ->Limited upside gain caused by the covered calls can be alleviated by going long with a call on the same position with a strike above the sold covered call -If the metrics outlined above are met and the market begins to act as if a correction is iminent, i.e. increasing prices with decreasing MACD, RSI, or volume consider: ->Purchasing additional put contracts out of the money but within the projected downside percentage within the projected timeline ->>i.e. QQQ put at a strike with a $6-10 price and a exp of 6 weeks ->>> A subsequent downside of 30% within that timeframe will net a 8.5x return at maximum downside, therefore, every $1000 purchased would net a $8260 profit -Continuing reevaluation of market conditions are necessary
Possible outcome example: -With an investment of $20000 into puts against QQQ; on 30% downside of QQQ: Gross profit =$147700 at 8.5x return. This can then be reinvested in PMI earning blocks (100 shares) within the lots (divisions of investable income based on stock holdings) already established to further compound returns. This gross profit will offset any losses occurring during the market downturns, which will be around 10% with proper hedging vs the market correction of 30-70%. My personal strategy will be to hedge all positions using covered call premiums to purchase puts with a net credit, and ensuring these hedges are in place when the RSI is above or trending strongly towards 80. I will be minimally hedging all tech positions regardless of RSI value in relation to the volatility of the current market and the high probability of short term 20% corrections because of outside socioeconomic factors and the internal behavior of the market.
Strategy for second move downwards: The second devaluation of the 2000 crash took 2 years to reach the bottom. This happened as the market behaves: unpredictably and incrementally. -Continue to purchase puts against QQQ considering reinvesting a portion of the capital gained from the initial put purchase to continue to either hedge against continued losses, or to generate income -Continue to hedge individual stocks by selling covered calls and hedging the position by purchasing puts with a net credit -> This will either limit losses in large downward moves or provide income to offset the losses and bring the cost bias of the shares held down to further future upside potential -> Continue to attempt to enact the PMI (passive monthly income) strategy with a goal rate of 10% yearly ATPI (after taxes, premiums, and inflation) -Use the capital gained to purchase blocks of high growth/high IV companies and value companies to continue to generate PMI at a goal rate of 10% ATPI
**Watch for a lower market valuation than mentioned above paired with an RSI of 85+ as this may indicate a preemptive market correction. As always, the market is unpredictable**
Post full correction: Any capital gained from the purchase and sale of puts should be reinvested into the strategy of choice based on previously established plan, i.e. reinvesting into PMI value stocks and high growth, high IV (implied volatility) stocks at a 3:1 ratio where high IV stocks will be able to fetch higher covered call premiums thus maximizing consistent, repeatable returns. -PMI value stocks mentioned above are a set of stocks of criteria I have created to establish that a company is worth investing in, is priced well, and can generate 1.5% passive monthly income (PMI) through the sale of covered calls and yearly dividends. This is based on my personal goal of a minimum 10% yearly return after taxes and inflation. This strategy will increase the likelihood of positive yearly returns in a bear market scenario if one should arise.
Disclaimer: These analyses are based on the monthly chart comparing the current IXIC trends with past market corrections which were also analyzed in the monthly chart view. There were no obvious correlations between MACD and Stochastic and no data was available for On Balance Volume. There was, however, a correlation between the market trend vs Bollinger Bands, wherein the candles rode the very upper limit of the Bollinger Bands, with the last candle at the peak of the 1999 bull market breaking the upper limit of the Bollinger Bands completely. However, this breakout is not repeated for the 2008, 2018, or 2020 corrections and all trends rode the very upper limit of the Bollinger Bands prior to correction. For these reasons I found no meaningful data to convince me to include Bollinger Bands in the analysis or preemptive planning for a future market correction. This is stated to illustrate that the analysis given in this article is A: not comprehensive, and B: should not be taken as a sole factor in your decision to act on current and future market conditions. As always, it is best to do your own research and draw your own conclusions. Good luck and hedge up.