The Guessing Game

 | Feb 02, 2012 | 8:48 AM EST  | Comments
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"Achieve success in any area of life by identifying the optimum strategies and repeating them until they become habits." --Charles J. Givens

When the market is going straight up, as it has for about six weeks, the focus of many market players is to come up with reasons why the trend should not continue. The search for turning points is always much more energetic when we are trending down, but strong uptrends also produce a crowd of people trying to guess when the end will come.

You really can't blame them for the constant focus on turning points. If you time the turns right you can make some good money, and the media always does a great job of encouraging us to be prognosticators. For many people, the master of the market is the individual who can accurately predict the twists and turns of the market beast at exactly the right time.

What many market players fail to recognize is that they would generally be better off if they simply stuck with whatever the prevailing trend might be and didn't even bother with the game of trying to call tops and bottoms. Just make sure you take some profits when things are extended, set some stops and then let the market do as it pleases. If you are using a sound money-management methodology, pick decent stocks and stick with the trend, you will make money. When the market turns, your stops will trigger and then you can sit back and decide your next move.

Unfortunately, human nature pushes us to try to be more clever than that. Few can resist the temptation of trying to nail the exact turning point. Rather than stick with a trend, we try to anticipate the turn. We sell off our winning stocks prematurely and sit in cash waiting for the pullback. Or even worse, we start shorting into the strength and look to make a killing when the inevitable reversal kicks in like we anticipated.

Trend-following has definitely been the best approach for this market since the low in March 2009, but it sure isn't nearly as easy as it sounds. The major problem is that in this market, extended stocks tend to become even more extended and if we take gains too aggressively into strength, we have a very hard time putting money back to work.

Yesterday was a particularly good example of that. We have been trending up for a while, things were finally looking a little tired, but suddenly we blasted higher on no particular news. If you are holding positions, that's great; you can lock in some gains or just keep on riding the move. But if you have idle cash that you want to put to work, it is much more problematic because after six weeks of uptrending, you will see few stocks with great entry points. Some folks have no problem buying stocks that are up numerous days and weeks on end. But for many technicians, their discipline will not allow them to buy much on a day like yesterday. You can always pick off a few trades, but aggressively putting big chunks of cash to work for position trades isn't easy on days like yesterday.

So here we are with a very strong uptrend in place but lots of chatter about why a turn in this market must be coming soon. Putting new money to work is difficult, but chasing still works.

If trading were simple, it wouldn't be so potentially lucrative. The key is to be aware of the challenges that exist and to be ready to react as conditions change. I keep fighting my inclination to look for a market top, but profit-taking into strength and the lack of charts with favorable setups is keeping my cash reserve high.

One thing I can't shake as I contemplate the market today is how fitting it would be if the announcement of the Facebook IPO marked a short-term top. It is a classic magazine cover-type indicator that reflects excessive positive sentiment. But until we actually have some weak price action, I have no plans to embrace the dark side.

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