Stick With Defense

 | Feb 04, 2014 | 4:24 PM EST
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After the pounding on Monday, the market was due for a bounce and that is what we had today. It wasn't anything special and many traders complained about how dull it was, but it was a relief that stocks stopped sinking.

Did the action today change anything? No. We are still in a downtrend and there are no signs yet that a V-shaped bounce will develop. The market beast likes to use bounces like this to make us think that the worst is over and that we had better buy or we will miss out. It is the when a bounce like this fails that the real pain of a correction sets in and sentiment becomes extremely negative.

I'm not predicting that this bounce is going to fail, but I see no reason to conclude that we have made a lasting low. Nothing in the price action suggests that the downtrend is ending. It is just a little relief bounce after ugly action -- nothing more and nothing less. Stick with defense for now.

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

Feb. 04, 2014 | 2:00 PM EST

Regaining Balance

  • Monday's selloff stung, so players are proceeding carefully.

The good news is that the indices are holding on to gains and slowly inching upward. The bad news is that volume is tepid and there isn't much energy. Overall, that isn't very surprising. After a day like yesterday, you'd expect to see a routine oversold bounce. Market players aren't going to pile back in immediately because the selling stung and they need to regain their balance.

Of course, if you have paid attention the last couple of years you know that all those V-shaped bounces started just like this. Stocks didn't just leap back up after a pullback. They started moving up slowly on light volume and then just keep going without any dips. The longer it continued to run, the more anxious the underinvested bulls became. Before you knew it, they were chasing the move again.

I've often said it was unlikely the market would bounce like that again and I was quickly proven wrong. Once again I'm predicting that this time it is different and that we aren't going to see the same sort of recovery we saw so often the last two years. As I've been discussing for a while, the character of the market has shifted. We no longer have the Fed providing a tailwind and the economic news is obviously a problem.

The good news is that even without a V-shaped bounce, the recent action should help us to sort out good stock picks. I like the opportunities being created and I'm optimistic that we'll do just as well even without a V-shaped recovery.

We'll see how we close. A weak finish will definitely confirm that this market has undergone a substantial change in character.

Feb. 04, 2014 | 10:48 AM EST

V-Shaped Bounce Is Unlikely

  • The market is returning to 'normal' this year.

The dip-buyers are hesitant but nibbling, which is holding the market up. The longer it stays green, the bolder they will become. But, right now, there are trust issues. What we have to watch closely are the intraday lows. If we lose them, it will trigger sell stops and it won't take much to retest yesterday's lows as well.

Buyers have become used to V-shaped bounces over the last few years and have lost sight of the fact that it isn't normal action to go straight back up after a drubbing. Typically, a market like we've had the past week or so creates "stuckholders" who are looking to escape into strength, as well as emboldened bears who want to short bounces.

Quite a few people wish they had sold down two weeks ago and if they can do it now with a smaller loss, they will likely do so. That is the psychology of why V-shaped bounces typically don't occur, but in 2013 this market made a mockery of normal human emotions. This market is returning to "normal" this year, which is why I think a V-shaped bounce is less likely.

I cut a couple things into strength this morning and added to BioTelemetry (BEAT), which is a new Sharkfolio position. The company won a patent suit and rather than drive the other company into bankruptcy by trying to collect, BEAT acquired the company instead. It looks like a strong deal and I believe it will provide good support for the stock.

At the time of publication, Rev Shark was long BEAT, although positions may change at any time.

Feb. 04, 2014 | 8:24 AM EST

Break the Inertia

  • During unexpected declines, the worst response is to do nothing.

The inertia of the mind urges it to slide down the easy slope of imagination, rather than to climb the steep slope of introspection. --Marcel Proust

On Monday the Nasdaq fell 2.6%, making for the index's worst loss since June 1, 2012. What is most remarkable about that is that we've gone this long without a significant pullback. When we go almost 20 months without a decline of some magnitude, a day like Monday hurts even more since people are even less prepared than they should normally be. Still, there remains a big group of folks who are confident the market will bounce right back, just as it has done so often in the last 20 months.

It is interesting to note that the 2.82% one-day decline in June 2012 turned out to be the bottom of a 12% decline. The next day, the market underwent a hammer reversal and it was straight back to the upside. The day after that, the market bottomed and stocks rallied for four months before another sharp decline kicked in.

Those sorts of ups and downs are the typical nature of the market, but 2013 action has caused many to let down their guard. We have forgotten how to play defense, not only because we haven't needed to, but because it has been so costly. Defense costs you money when the market consistently bounces right back from dips, as it did throughout last year.

When the market undergoes a correction, as it is now, what's most difficult for most folks is the question of what they should do if they haven't taken defensive steps quickly enough. People tend to freeze amid sharp pullbacks, and then they are afraid that if they sell, it will be at the exact wrong time. So they end up just sitting there, doing nothing, while hoping and praying that the market will bounce back and bail them out.

We have all heard stories about people who made a huge amount of money in the bubble days, back in 1999 and 2000, only to give it all back in the following few years. The reason so many did this was that they froze. They had been convinced that the market would turn around at any moment, and that all the positions they were still holding would bounce back and they would be fine.

Inertia is what kills you in downtrends. The inability to take any action as losses mount is what wipes out traders. This is especially dangerous when you have large positions, and you keep adding to them rather than cutting back.

My advice is simple: Do something. It doesn't much matter what that "something" is. But you need to break the cycle of inertia quickly. If a stock bounces back, sell a little bit. If something is declining, set a stop and then honor that stop if the stock hits it.

The key to dealing with downtrends is to stop the bleeding so that you will be ready to pounce on the opportunities when conditions improve. If you ride things down, then the likelihood is that you will just try to ride them back up when the broad market bounces. The best opportunities usually won't be in the stocks that you rode down. The big bounces will be found elsewhere -- but you may be married to your baggage.

Again -- if the market is causing you stress and uncertainty, and if you are feeling frozen, take some action and don't worry too much about being right or wrong. The key is that you break the cycle of inertia and are ready to move.

We have a little oversold bounce kicking in, but the mood is cautious and it is going to take some work for the dip buyers to rebuild their confidence. Don't be too fast in deploying your precious capital.

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