The First Rule of Market Corrections

 | Feb 03, 2014 | 4:25 PM EST
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Even if you are mentally prepared for it, it still can still be quite shocking how bad the market can act when it breaks down. It was an absolutely horrendous day, and I can't recall the last time we had such aggressive selling. The point losses were huge, volume was heavy and breadth was terrible. There was absolutely no sign of dip-buying and no place to hide.

The good news is that the media are now yammering about 10% corrections and how this isn't just a run-of-the-mill pullback. They actually sound surprised that momentum also works to the downside.

The first rule of market corrections is to get out of the way. Often, people are afraid that their selling will be poorly timed, but even if it is, it is still cheap insurance. There really is no reason to believe that we are going to go straight back up like we did so many times last year. The key to dealing with this is to carry a high level of cash and then be patient why new opportunities develop. When the market improves, there will be plenty of time to put cash to work again.

Are we going lower from here? We are a bit oversold and that could give a little bounce, but being oversold didn't help at all today. There isn't much technical support and, most importantly, the character of the market has changed dramatically. The Fed is no longer saving us, and bad economic news like the PMI report today matters.

Keep those cash levels high and stay patient. It will pay off nicely but in the near term, make sure you don't let this market hurt you too much.

Have a good evening. I'll see you tomorrow.

Feb. 03, 2014 | 12:57 PM EST

Decidedly Unpleasant Action

  • Still, it's a return to normal.

After the action in 2013, many market players have forgotten what a real downtrend feels like. We are getting a taste today, and it's not very appetizing. The main difference on my screen is that there is no place to hide. Are a couple big-caps are still holding up, among them Twitter (TWTR) and Tesla (TSLA), but folks are selling most everything else across the board.

When we see action like this, we constantly hear the word "oversold," but when the market is breaking down like this, the oversold bounces are selling opportunities. Many market players have become so used to buying dips that it has become reflexive, and they are now finding themselves trapped -- which is making things much worse.

A number of times in the past year, I felt rather foolish when I took defensive action at the first sign of trouble. The market came back so quickly that it was extremely difficult to reload positions. It almost became a joke: The market was a buy as soon as Investor's Business Daily declared that the market was in a correction.

Today's action isn't very pleasant, but it is a return to normal. You deal with it buy staying defensive, building shopping lists and inching in very slowly, if at all.

One stock I've added to an existing position today is BioTelemetry (BEAT). There are a number of others I'd like to add like Himax Technologies (HIMX) and Novadaq Technologies (NVDQ), but I see no reason to start buying yet.

Feb. 03, 2014 | 10:40 AM EST

Market Pressure Mounts

  • It actually feels a bit panicky.

The market is under severe pressure as the January ISM manufacturing number missed badly. Of course, it is being blamed on the cold, snowy weather, but that isn't making buyers feel any better.

The bad news is that the S&P 500 is making a lower low and testing the next level of underlying support around 1765. The market went up so quickly last fall that it never really built much support, so 1750 isn't out of the question with the current level of momentum.

Despite the poor action, big-caps Facebook (FB), Twitter (TWTR) and Tesla (TSLA) have been holding up. The problem is that the longer the market is under pressure, the harder it is for these leaders to hold up. Eventually, holders tend to flee to the safety of cash when the overall market is under so much pressure.

I sold down a few stocks this morning but probably should have sold more. I'm going to stand aside and let the selling play out for now. We are seeing wholesale dumping of positions. Stocks are being sold regardless of individual qualities, and when that happens you just have to stay out of the way and wait for support.

It actually feels a bit panicky, which is painful if you are holding positions but helpful as far as getting to support. Be careful. The data releases were poor and that really matters.

Feb. 03, 2014 | 8:13 AM EST

Stay Flexible in This Market

  • The opportunities will develop; we have to seize them.

Things turn out best for the people who make the best of the way things turn out. --John Wooden

The market lost ground in January, the Nikkei is now officially in correction territory after losing 10% and the Super Bowl was a dud.  It is making for a gloomy start to the week but it is making me feel optimistic.

One of my biggest complaints about the market the last few years is how little human emotion there seemed to be. Psychology seldom mattered and the smartest market players were those who ignored everything and simply stayed long. There was little edge to trying to time the market and, even worse, stock picking was becoming irrelevant in a market with a permanent upside bias.

Things have changed in 2014 for a number of reasons. The central bankers have lost their sway, emerging markets are struggling and the China miracle has confronted reality. Many market players are learning again that the market moves in two directions and that they won't be bailed out if they pick bad stocks.

Why does this poor action excite me? Because it is like the old days. There are pockets of momentum within the gloom, it actually is effective to take profits and to time the market and being an aggressive trader gives you an edge.

One of the most remarkable things about the market in 2013 was how poorly hedge funds performed relative to the indices. It was one of the worst years ever for the folks who are supposed to be the 'smart money'. The problem was that none of things that hedge fund managers and aggressive traders tend to do gave them any sort of edge. Timing the market was a disaster. If you sold; you regretted it almost immediately. If you held cash for any period of time, it cost you -- and if you didn't just buy and hold, you struggled.

Our job now is to adapt to a market has under undergone a substantial change in character. How do we deal with downtrends, failed bounces, gap down opens and a market that doesn't immediately recover? The answer is that we have to manage things much more carefully. We have to be disciplined and not let losses build. When a stock acts poorly we have to cut it because the market won't bail us out so easily in this environment.

The fun part of this sort of market is that the hunt for good stock picks is much more rewarded. The good stocks stand out much more and the potential for outperformance is much higher if you can find what is moving.  

If you just trade overall market direction, with a bullish bias, you are going to miss 2013 very much. But if you like to dig through charts, look at earnings reports and examine news, then you are going to have a lot of fun looking for the stocks that are going to perform in a tough market.

This market is not easy. It is tough to trade against the trend and panic selling and negative sentiment can catch you by surprise but those emotions also create opportunity. The key is to stay flexible and open minded. The opportunities will develop and we just have to be ready to seize them.

Things don't look too hot this morning, but it is going to be interesting to see what the dip buyers do once we settle down and start the week. This is the time for traders to go to work and show why we approach the market in the way we do.

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