Rev's Forum: Walking the High Wire

 | Feb 16, 2017 | 6:37 AM EST
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"The key to balancing on a tightrope is to lower the body's center of gravity toward the wire."

-- SmithsonianMag.com

V-shaped moves are nothing new for this market, but this one is a little different. It is occurring as the market moves into unchartered territory. The Dow Jones, the S&P 500 and the Nasdaq have enjoyed five consecutive all-time highs on five consecutive days for the first time since 1992. Not even in the bubble days of 1999-2000 was there a move as lopsided as this.

The first reaction of most market observers to this action is "the market needs a rest". It simply isn't possible for this to continue unabated for very long. There are many market players with some nice gains and sooner or later they will make a move to protect them. The folks sitting on the sidelines with idle cash are going to hesitate to chase things that are grossly extended, and that buying power will subside.

The problem is that all the arguments that justify caution at this point could have been made equally well two days ago. The extended market has only become more extended and if you were prematurely cautious you have missed. Even worse, if you have attempted to call a market top, you have probably helped to feed the upside when forced to cover shorts.

So how do we deal with this market, which has some amazingly strong momentum but now is so extended it feels ridiculous to try to chase it?

The first thing to keep in mind is that it probably isn't a good idea to anticipate a major reversal. A market with this much strength isn't going to reverse and go straight down. Forget trying to call a major top right now.

The most likely scenario is that there is finally a pause and a little downside, but underinvested bulls provide strong dip buying support. This process of support will prevent any significant downside from developing quickly. It is only after a lack of progress by the dip buyers that the character of the action might shift.

The second thing to focus on in this market is protection of gains. The key to superior performance is to keep your accounts as close to highs as possible. That means systematically locking in gains and making sure you are stubborn about allowing stocks to pull back. You can sell into strength, use trailing stops, moving average support or any number of other approaches, but don't let the fact that the market is at highs prevent you from thinking about defense. If you focus on holding on to gains in your positions, you will be well positioned when the inevitable turn comes.

I suggest all the time that market players shouldn't worry about trying to call turns. If you focus on managing your individual positions carefully, you don't need to. I've been using the recent run-up to lock in some gains, and I'm using stops to protect the gains I have left. Since so many stocks are extended and not attractive technically, at this point I can't redeploy the capital I've raised.

Thus, by default, my cash levels have increased and I am more cautious. If I can find good stocks I will buy them, but if I don't then I'm ready for a top without going through the exercise of trying to predict one.

At this point in a strong rally, the market timing predictions tend to grow loud and shrill. So many pundits want to be the hero that calls the exact moment that the market tops. It is a great way to gain some attention, but it is unproductive from a trading standpoint. Even if someone does nail the exact moment the top is hit, that doesn't mean they will be effective in navigating the downside.

Most market players would be far better off staying focused on managing positions rather than predicting the gyrations in the indices. Stay focused on keeping those accounts near highs and the market timing will take care of itself.

We have a flattish start once again, but these slow starts have led to strength later in the day six straight times now. Early weakness has been a trap, so stay wary and look for a weak finish to signal that momentum may finally cool off.

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