Being a Little More Cautious

 | Mar 03, 2014 | 12:32 PM EST
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The market took a sharp turn on Friday, after one to two weeks of the S&P 500, Nasdaq Composite and Russell 2000 all hitting new multi-year highs (and all-time highs in the case of the S&P 500 and Russell 2000). This leaves many traders and short-term investors concerned that yet another steep retracement like the one seen in late January and early February is just getting under way.

It is true that the market has been showing signs of upside exhaustion since mid-February, as I mentioned in Columnist Conversation last week, and I am more cautious this time around ... at least for the moment.

SPX Daily

On the larger weekly time frame, the indices are indeed continuing to show exhaustion at these levels, but we are not yet seeing a shift on the smaller time frames that would support another strong multi-week pullback. While the upside momentum slowed in most of the major indices between Feb. 11 and 12, leading to a shift in the uptrend channel that began on the daily time frame on Feb. 5, the momentum within the channel itself has not. The only exception was the downside on Friday afternoon into this morning. Overall, however, the corrections off the upper end of the channel have been more gradual than the upswings within the channel.

SPX 30-Minute

The typical correction that results off highs like this, following the third high within the channel, is a more minor correction than is seen when there are more rapid and evenly-paced swings off the highs and lows of that gradual channel. In those cases, where the action within the channel looks similar to "V" and inverted "V"s, corrections such as the January pullback are more common.

Instead, the current action suggests that the rapid selloff that is currently under way intraday is more likely to have a second wave of selling follow it on the 30-90 minute time frame that I typically look for on such a reversal. And the current action suggests that a second wave of correction this time risks a greater struggle once it approaches support such as the 20-day moving average. If the momentum slows on this second wave of downside, the market can more easily return to strike a higher high before finally giving way to a larger pullback. Sometimes it may even do this twice in a row before the "real" correction on the daily time frame can take hold.

As in January, I am once again in a position for a correction. However, the details mentioned above leave me treating this position differently and less aggressively. Instead of the "sell and hold" mentality of a pure swing trader, I'm breaking up half of the position as a swing trade, with the objective of holding several weeks and treating part of the position as more of a short-term play.

On the position that I intend for a multi-week swing trade, I am monitoring the 30-minute charts carefully. I have a wider-than-average stop level based on price (with a smaller position as a result) to allow for the potential extension of prior highs. Typically, I will use above prior highs as a stop. This time, I am using an extension based upon Fibonacci levels. A move back to new highs is unlikely to push past the 23.6%-38.2% extension of the prior highs. While I believe the risk to be greater on this portion of the trade, the short-term portion will help offset the risk.

If I were looking at this as a swing trade alone, I would be much more likely to pass and wait another one to three weeks or look for individual securities within the indices that are showing greater relative weakness than the indices as a whole.

Columnist Conversations

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