Rev's Forum: Preparing for the Beauty of a Market Disaster

 | Aug 11, 2017 | 7:42 AM EDT
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"And she thought then how strange it was that disaster -- the sort of disaster that drained the blood from your body and took the air out of your lungs and hit you again and again in the face -- could be, at times, such a thing of beauty."
Anita Shreve

The market has been exhibiting signs of stress for a few weeks now and finally succumbed to gravity yesterday. The Nasdaq took a healthy hit of more than 2% and the Russell 2000 fell all the way to its 200-day simple moving average for the first time since the presidential election last November. The misleading Dow Jones Industrial Average is the only index still above its 50-day simple moving average.

There is no shortage of data confirming that the price action is negative. Breadth, the number of new lows, support levels and so on all are indicating that there are problems in this market. Investor's Business Daily now proclaims that the "uptrend is under pressure."

For the most part, the indices merely are catching up with what quite a few individual stocks have been hinting at for a while. Earnings season has not gone particular well, although the numbers have been good overall. The reaction to even solid reports has tended toward a "sell the news" reaction.

Nvidia Corp. (NVDA) , which has been one of the top momentum stocks recently, is providing another example this morning of how stocks have reacted to earnings. The company had a solid beat but the market is unhappy that guidance isn't better. The stock was trading off about $12 in the premarket.

The big question for us to consider at this point is whether the bears finally can generate some sustained downside momentum. The bears have produced a number of short-lived selloffs since the election, but they haven't produced the big turn that they continue to warn us about.

Since the election there have been about six selloffs, but in nearly every case they only have lasted a day or two. There has been no significant downside follow through.

This is obviously a function of the inclination toward dip buying. Market players consistently have been rewarded when they buy weakness, so that is what they do. Should those dip buyers be trapped in a failed bounce, the potential for accelerated selling increases. However, there seems to be little fear of that happening in this market.

While the pattern of action has been quick recoveries, it doesn't relieve us of the responsibility to make some defensive moves just in case that a major change in market character finally is taking place. Our No. 1 job is to protect our precious capital, so when we have a day such as yesterday there is no choice but to be ready for a continuation of the selling. If the market finds its footing then we can put capital back to work, but avoiding losses is more important at this point than making new buys.

Market pullbacks create opportunity, but the goal isn't to buy stocks at the exact low. Rather, it is to buy them when they have the best chance of a sustained upside move. If you are day trading you can look for very quick oversold bounces, but if you have longer time frames it is better to wait for some signs of support levels before you start putting money to work.

The bears believe that the long-awaited market correction is starting to take place. We don't need to decide if they are right or wrong this morning. We simply need to be in a position to avoid impairing capital just in case the pessimists finally are correct.

Proceed with caution and focus on protection of capital. This selloff is producing opportunities, but we need patience to find the best entry points for new buys.

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