Steve McDonald: Our guest is Karim Rahemtulla, the Club’s Options Strategist, and he’s here to talk about support levels in the S&P.

Welcome, Karim.

Karim Rahemtulla: Thanks, Steve. Glad to be here.

SM: It’s nice to have you. Just so we’re all on the same level, what are support levels? How do they work?

KR: Well, these levels are where the market’s traded down. We look for the last time it fell and at what level it fell to before it recovered.

And usually when it falls and has a sharp correction like we’ve had – 10% or so – you want to look for it to retest those levels that it fell to.

So right now, the market’s trying to retest. It’s already retested twice and might retest a third time.

And each time it retests that level, you’re looking for it to bounce back up.

And if it doesn’t bounce back up and go through those levels, then you’re in for more pain.

SM: So that was my next question. We’ve been bouncing off of these support levels in the S&P and the Dow. What’s going to drive it below? What’s going to drive it up? What’s going to have to happen?

KR: Well, our biggest problem right now is what’s happening in the political environment. We’re not getting very sound information coming from our government.

One day, we’re looking at things like tariffs. The next day, we’re looking at exemptions. Then we’re seeing news about internet companies being taxed or Amazon being broken up.

You’ve got all this stuff coming out that’s making investors very nervous and very fearful. But the flip side is the economy’s doing great.

So you’ve got to decide what you’re going to look at. Are you going to look at the short-term noise that’s out there? Or are you going to look at the bigger picture?

SM: So how do you use this?

KR: It’s usually a short-term indicator. They look at averages based on 50-day moving averages, 100-day moving averages, 200-day moving averages. So the indicator that you don’t want to break is the 200-day moving average because that’s a longer-term indicator.

SM: And you consider the 200-day moving average a support level?

KR: That’s the support level that you don’t want to fall below right now.

SM: And where do people find this?

KR: You can go to pretty much any financial site and it’ll show you a chart that has a line going through different things. Typically, it’ll show 50 DMA, 100 DMA or 200 DMA. And the DMA stands for the daily moving average.

SM: In your experience, and I know you’ve been around the markets a long time, how often do the support levels hold? How often do they fail on a percentage basis?

KR: I would say that, depending on the fundamentals, it’s hard to put a percentage on it. It’s easier to look at whether they’ll fail or not.

And to look at that, you’ve got to look at also adding in volatility. And volatility is very high right now compared with where it was last year – but not historically speaking.

So there’s several factors that go in there. But how many crashes have we had of a 20%-plus magnitude in the last 30 years? I can probably count eight or nine. It doesn’t happen that often.

SM: How do people use it to make money?

KR: Well, when you look at where the indices are trading, as they approach these support levels, if they touch the support levels and start to move back up – and you can see this happening in real time in front of your face – you want to jump in usually with an option because that gives you a lot of leverage at a very low cost.

And you want to jump in there and say, okay, if this bounces off the support, and comes back up 5% or 7%, that’s a huge move.

You know, you’re talking about a stock that could go from being down $8.00 intraday to closing up $25.00 the same day if it’s a $200 stock. Some could go up 8%, 9%, 15% or 20% in one day.

And the way to benefit the most from that is to have an option. And right now, the weekly options are doing really well because they’re so cheap.

SM: Interesting. So we need to look at the 200-day moving average. It sounds like a plan to me.

KR: And you have to look at what’s happening in the economy in general. Unemployment’s low, interest rates are relatively low, people are spending money, there’s lines at restaurants and people are buying houses.

So is there something that you’re missing? Usually, no matter how well the economy does, if you’re in overvalued stocks, you’re going to get hurt.

SM: Yeah, everybody’s learning that the hard way, I’m afraid. Karim, as always, it’s a pleasure to have you on.

KR: Great. Thank you, Steve.

Source: Investment U