The U.S. stock market has gone from a roller coaster performance to a free fall. Here’s the parachute! A few simple, hands-on tips that will help you make the best of what we’ve been dealt.

It would be easier to just say: “I told you so”. In our ETF Profit Strategy Newsletter we’ve been warning subscribers of this financial unraveling all along, but “Success consists of going from failure to failure without loss of enthusiasm” (Winston Churchill). So, if you are one of the poor souls that hasn’t been warned in time, here’s your second chance.

What drives the market?

News drives the market, right? The day Obama was announced as the new President, the S&P 500 (AMEX: SPY) rallied sharply. The two days that followed were marked by steep losses, even though China announced a $586 billion bailout package. Record low unemployment numbers were released on Friday, yet the Dow Jones (AMEX: DIA) managed to end up higher.

The financial meltdown and surrounding news have sent the markets into a downward spiral. Financial woes were the straw that broke the camel’s back. Truth be told, the “camel” was already at a breaking point to begin with. Current news adds nuances but bigger forces have already penciled the outcome.

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What caused this bear market?

Financial institutions, corporations and consumers gorged on easily available credit. The excess money and liquidity served as breeding grounds for “decoy wealth”. What goes up must come down. When you prick a full air balloon, the air doesn’t just seep out quietly, it busts out with a bang. We’ve seen one of the biggest equity bubbles in human history. What was the extent of the bubble?

The S&P 500 rallied from 190 in 1982 to 1,500 in 2000. The price/earnings (P/E) ratio peaked in 2001 at 65, the highest level on record. By 2007 the S&P 500 climbed to new all-time highs while P/E ratios fell to below 20.

The depth of real economic growth since the mid-80s was much shallower than during the 1945 – 1960 period. A prime example is General Electric (NYSE: GE), the oldest name in the Dow. Through 1966, GE was one of the finest manufacturing conglomerates in the world. By the early 80s, accountants had taken over and the company morphed into a financial concern (GE Financial).

How low will it go?

What if somebody would have told you a year ago that the Dow Jones will drop from 14,000 to below 8,000? What if someone were to tell you the Dow will drop to below 2,000?

The aftermath of bubbles often results in a complete eradication of all gains. This bubble started in the mid-80s with the Dow at around 1,000.

Is Dow 1,000 possible? The first inclination is to say NO WAY! Spend some time to study what happened in Japan, this will truly open your eyes. For the “big skinny” on Japan, sign up for our ETF Profit Strategy Newsletter where we analyzed the parallels between Japan and the U.S. FYI, both bear markets started with deterioration in the financial sector, …

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What is the extent of the bear?

This bear goes deep. The major U.S. benchmarks are down, the international MSCI EAFE Index (NYSEarca: EFA) is down big time, Gold (NYSEarca: GLD) has dropped even though all the uncertainty should have propelled it to new highs. Silver (AMEX: SLV) off by over 70% and agricultural commodities (AMEX: DBA) have dropped like a stone. Who would have thought oil (AMEX: USO) would ever revisit $60 / barrel after peaking at $147 / barrel.

Don’t be fooled by sucker rallies

During the Great Depression, before the market bottomed in 1932, there were six sucker rallies with 20%+ gains before the market actually bottomed. In fact, eight of the ten biggest percentage gains occurred during the Great Depression. Seven of them were mere bumps on the Dow’s way to lower grounds.

On average, the Dow declined another 60% after each bounce before the bottom was reached (see image below, courtesy of the ETF Profit Strategy Newsletter). For those who are not familiar with the nitty-gritty details of the Great Depression, let it be known that the Dow Jones dropped 95% in less than 3 years.

Know how to use sucker rallies

Sucker rallies are great if you can spot them and don’t get fooled by them. Sucker rallies, or counter trend rallies offer an excellent opportunity to reduce beta. Beta measures a stock’s or ETF’s volatility compared to the S&P 500. The PowerShares WilderHill Clean Energy Portfolio (NYSEarca: PBW) for example comes with a beta of 1.89. This means PBW moves 1.89x the S&P500.

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In other words, use counter trend rallies to eliminate ETFs that drop like a stone in a down market.

What should I do?

Rule #1: Use common sense. Stay away from the conventional Wall Street wisdom that told you to buy in July, August and September because stocks are cheap. Are stocks cheap after the October carnage?

To answer this, you need to measure the Dow Jones in real money, real currency. The Dow measured in gold reveals the Dow’s true value.

Analyzing dividends rather than P/E ratios to measure value provides real insight. P/E ratios are projected and thus subject to change. Dividends are either paid or not, you can't manipulate dividend reports. The current dividend yield compared with historic dividend yield paints a compelling picture.

Sign up for the ETF Profit Strategy Newsletter to find out how the Dow measures up against the Real Dow (measured in gold) and what dividends tell us about current valuations.