How To Profit In Overbought Markets (KBE, XLF,XLK, SPY)

December 10, 2010

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Courtesy of ETF Guide

How can you have your cake and eat it too? In other words, how can you profit from an overextended market without getting burned?

It’s said that an ounce of prevention is worth more than a pound of cure.

Fortunately for investors today, prevention seems to be overrated as the Fed is pumping liquidity into the markets.

The Fed feels indifferent that QE2, which is not much more than an asset purchase program, rewards the very banks (NYSEArca: KBE) and financial institutions (NYSEArca: XLF) that profited immensely from creating the 2007 bubble.

Ironically, the money being spent on “preventing” a continuation of the economic meltdown is inflating another bubble. Today’s easy money is coming from a different spigot, but it’ll have the same effect – another bubble.

Stairs Up – Elevator Down

All is well as long as prices go up, but that can reverse suddenly. A commenter on ETFguide.com’s message board used the analogy that the market is climbing up the stairs but taking the elevator down.

The chart below shows the long-term performance of the S&P 500 (SNP: ^GSPC) since the 2000 tech (NYSEArca: XLK) crash in one month candles. Note how the bear market moves much faster than a bull market.

In this article we’ll discuss 1) How to make money on the upside without being vulnerable to another steep sell off and 2) What the chances are of a sharp correction visiting Wall Street.

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