By Michael McCarthy

The days ahead are packed with news investors ignore at their own risk. PMIs in China and Europe. Inflation readings in Japan and Australia. Durable goods and other national accounts data in the US. Additionally in the US, there is an FOMC meeting, an interest rate decision and the busiest week of the company reporting season so far.

Many shifts in market thinking are possible this week.

The volatility of many markets is higher, apparently in recognition of these potentially game-changing events. Unfortunately for Australian investors, this increase in market action comes as the share market index trades near the lows of the range.

Those who favour the view that markets are organic in nature are often drawn to the price action. The actual moves of a currency, a share or an index are read as primary evidence – an expression of the collective will of all participants. The current price, relative to its history, contains information about market conditions and possible future moves. That’s why this chart is unsettling.

After peaking in May, the index is down more than 5%. In the last two weeks, it has tested important chart support around 5,660, making a lower low each time. Many chartists interpret this behaviour as a sign of overall market weakness. The bounce yesterday, and positive overnight leads, suggests the market is moving away from the danger zone. However, any sudden shocks could see this important level breached.

Investors chose to buy at the same index level as before, causing a bounce. A move higher from here would suggest a test of at least 5,825, and possibly 6,000.

However, a fall through this support, and a daily and/or weekly close below 5,660, could bring sellers out of the woodwork. The technical picture may deteriorate swiftly considering the events of this week. The good news is that there is a lot of previous action between current market levels and 5,000. A support level at 5,400 coincides nicely with the 61.8% retracement of the rally from November to April, and may prove a turning point if the market does sell down.

At the bottom of the chart is a Relative Strength Index (RSI) indicator. The fall through 50% is also a negative development. Further, the RSI is nowhere near oversold territory (below 20%), suggesting little to slow momentum should the support level break.

The “right” response is dependent on investors’ individual circumstances. Ideally, when the Australia 200 index was closer to 6,000, investors sold stock, bought put options or rotated into more capital stable or undervalued stocks. Investors who acted at that point may now watch and see (ready to pounce on pre-selected stocks), take profits on put options should the market bounce, or ride their reduced exposures to lower levels for such an opportunity.

It’s never too late to act. If the index signals lower levels by closing below 5,660, a quick response is available using what are known in wholesale financial markets as equity swaps. Individual investors know them as CFDs. CFDs (Contracts for Differences) are a “plain vanilla” derivative, as they change in value at a constant rate with the underlying market.

It’s important that any investor considering CFDs understands the power of leverage. While allowing investors to secure significant hedging positions with a small amount of capital, leverage can magnify potential losses, as well as potential gains. Nevertheless, for those willing to make the effort to understand these powerful investment tools, there is an opportunity to quickly and efficiently hedge a market portfolio with a single index CFD transaction.