Too Costly to Be Prematurely Bearish

 | Jan 17, 2013 | 7:40 AM EST  | Comments
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Anticipate the difficult by managing the easy. --Lao Tzu

For five days now, the market has made very little upside progress -- but, on the other hand, it hasn't pulled back at all. The big question for us to ponder is whether this slowing momentum is an indication of an impending correction, or if it's just a period of rest that creates the foundation for a breakout move to the upside.

The bears have been anxiously anticipating a market collapse. They tell us that sentiment is too positive, that earnings season will be disappointing, that the political debate over the debt ceiling will be a problem, and that the weak economy will plague us, especially since no new quantitative easing is likely from the Fed.

The bulls' response is to shrug and to point out that stocks continue to act fine despite the doom and gloom from the bears. The price action has been quite good, and all the recent dips have been bought rather aggressively. Maybe stocks aren't roaring higher, but the indices are consolidating and there is plenty of support.

The bulls might also point out that the response to early earnings reports -- from Goldman Sachs (GS), JPMorgan Chase (JPM) and eBay (EBAY) -- has been quite good so far. Expectations are low, and stocks have attracted buyers even after reports that are nothing special.

One of the main themes I've been writing about lately is to not anticipate, but to play the action that is in front of us. The time to be bearish is when there is some actual price weakness and technical damage. It is very costly to be prematurely bearish, especially when there is a tendency for uptrends to last longer than most people think they will.

Keep in mind that this non-anticipatory strategy doesn't mean being foolhardy and wildly bullish. No matter what the market is doing, it is extremely important to have strict trading discipline. That is what protects you when the inevitable reversal occurs. You must have a methodology that cuts losses and reaps gains. You can't turn into a buy-and-hold investor just because we are in an uptrend. It is still necessary to manage positions and make sure you don't let your profits slip away.

Although I have been quite clear about maintaining a bullish bias lately, I have been raising cash as a function of my trading methodology. I have taken some stops when things have sold off, and I have locked in some gains into strength. In a good market, I will find new things to buy and keep my capital in play -- but, the last few days, I'm finding it increasingly difficult to find new entries I like. As a result, my cash position builds and I reduce my market exposure.

In some ways this isn't that different from the anticipatory market timing of which I am critical, but the difference is that I'm letting the stocks make the decision. I'm not trying to impose my theories on the market. I'm simply doing what the market allows me to do. I continue to dig for things to buy, and I am not interested in shorting. Still, my positioning is more cautious, because I'm seeing a dwindling supply of stocks that are acting the way I like.

Lately the dip-buyers have been fast to buy weak opens, which has been good for the market. We'll see what happens today when the market opens a little stronger. That might actually be a negative, since it invites selling into strength.

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