One age ends, and another begins. It is the way of things. But, it doesn't happen all at once. --Derek Donais
On Wednesday the market suffered its worst bout of selling so far in 2013. We have only had one other weak day this year so, as sell-offs go, it wasn't all that bad. But the question now is whether this is the start of a market top or just a hiccup before the uptrend continues.
My advice since the first of the year has been to stick with the uptrend until there is a change in price action. The bears have been talking about all the negatives ever since the market gapped up on the fiscal cliff deal, but it simply hasn't matter. But when we have a day like yesterday, we have to start wondering whether the market is going to start embracing those negatives.
The main excuse for the selling yesterday was the minutes of the FOMC meeting, which raised questions about how much longer quantitative easing would continue. Given that this has been the primary market driver for the last three years or so, it is understandable that any talk about cutting back would spook the market a bit. It is a good excuse for selling, and now the issue is whether it will build.
Typically, it has been a mistake to be too bearish too quickly. The last time we saw a poor day and a close at the lows, in early February, the market immediately reversed the next day and resumed the slow upward trend. Quick reverses upward have been extremely common, and overly aggressive bears have often found themselves squeezed.
In view of this behavior, I'm not ready to declare that we have seen the highs but I am shifting my market bias from uptrend to a topping process. Markets usually don't just roll over and go straight down after a good uptrend. It takes time for a top to form. We will see some bounce attempts fail and we'll see the dip buyers give it another try or two. The difference is that the momentum doesn't build and the strength is sold. That is what I'm looking for.
The way to deal with this is to make sure stops are extremely tight and cut stocks that are lagging. You don't need to sell everything and hide in a hole, but don't give your stocks much room to misbehave. The key is to protect recent gains and don't get caught if a full-fledged downtrend emerges.
The good thing about the topping process is that it allows us the ability to exit without too much pain, but the key is not to be frozen into inaction. The biggest losses occur when you fail to recognize that the trend is shifting and you are too stubborn to let stocks go.
You don't have to be a hardcore bear but you need to adjust your mindset and be prepared for a change in market character. The market is likely to bounce soon and try to suck us back in, so increased caution is required.