Prepare at this Pause

 | Jan 31, 2013 | 7:57 AM EST  | Comments
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IWM

By failing to prepare, you are preparing to fail. -- John Wooden

My advice lately has been quite clear. Stick with the trend, don't keep trying to anticipate a top and don't become bearish until there is some actual price weakness.  That has worked pretty well recently, but like most things in the market it isn't quite as simple as it sounds.

The big question we have to grapple with now is whether a slight weakening in the price action is sufficient to justify a more bearish stance. 

Yesterday the IWM fell 1.2% and suffered its worst single day of performance since Nov. 14, which was the bottom of the pullback that set up the recent rally.  That is the first poor action in quite a while and the question is whether it is sufficient justification to join the bears, who have been yammering and complaining about this market since the first of the year.

While a weak day like this warrants additional caution, it isn't enough to declare the recent uptrend dead. It is very possible that this is a signal that a topping process has commenced, but the important thing to keep in mind is that the market is not likely to suddenly collapse and go straight down from here. In fact, I see a large number of stocks gapping up this morning on some strong earnings reports and we still had more than 350 new highs yesterday.

But when an index falls like that, it is a warning sign and requires us to think more defensively. We need not unload all our long positions, especially if they are still technically intact, but we want to be stingy about giving back gains and we want to focus on keeping our account as close to recent highs as possible.

The big danger at this point is that we push too hard to stay with stocks that have worked and don't cut them fast enough as they falter. There are always market players who are quick to forgive the market its sins because they have enjoyed the rally lately and don't want to give up on it.  Greed sets in and that is always the most dangerous of emotions. You can always find ways to ignore negatives if you want, but it is protecting gains that is key.

Probably the best thing you can do at this juncture is look hard at your individual holdings and make sure you have some tight stops. It is not giving back gains that helps you produce exceptional returns. Anyone can ride the market up and down, but the trader who refuses to give back profits when thing turn ugly is the one who will excel.

Over the last few days my cash position has grown quite a bit as a number of individual stocks that I own have started to weaken and I've cut them. To me, that is always the most important market indicator. The indices still look solid and have done nothing so far to undercut the recent uptrend, but the action under the surface has not been as upbeat and that has required some defensive action.

Don't turn into a big bear just because we have had a day or two of weakness, but don't stick your head in the sand and ignore the issues either. Set stops, protect gains and be more selective with your buys. If you do that you'll be in good shape if this market pause turns into something more dire.

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