Be Ready for Anything

 | Aug 24, 2011 | 8:42 AM EDT
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Young men know the rules, but old men know the exceptions.
-- Oliver Wendell Holmes

Since the market crash in 2008 and early 2009, old-time traders tend to agree that stocks just don't move in the same manner that they used to. This change in market behavior had been caused primarily by the growth of high-frequency and computerized trading, but the flood of cheap capital created by the Fed's quantitative easing program has also had a big impact. The fact that we crashed in the first place and have been in the worst economy since the Great Depression also has had a major impact on the psyche of investors and changed behavior as well.

I can go on at great length about what has changed about the market action in recent years, but it is far more important that we focus on how to adapt and navigate through this new environment. Many of the things that worked well in the past just don't work as well now, and we need to understand that and adapt.

The most noteworthy action in the market since the low in March 2009 is how fast we have recovered every time we have corrected a bit. It has been an extremely unfriendly environment for the bears and a very good one for aggressive dip-buying. By far the best strategy has been to buy weakness and then ride the ensuing uptrend to the point where it seems ridiculous. Buy the dip and don't sell the rips has been a good rule of thumb.

The question we now face is whether the conditions are in place for that sort of action to occur again, or whether things have changed again. Is the recent downtrend in the economy and the problems with European sovereign debt going to finally change the exceptional resiliency that we have seen so often over the past couple years?

Every time I start think that the market can't possibly roar back like it has so often, it seems to do it again, so I've been much more inclined to give bounces more room and to not try to fade them in the same manner I would a few years ago. Betting against "V"-shaped recoveries has been the worst thing you can do in this market for a very long time.

The big problem that this tendency toward quick recoveries creates is that chart setups don't develop very well. We don't have solid bases and good support levels to play off of when things bounce straight back up. In fact, buying when stocks are extended or overbought has worked well.

I bring this topic up this morning because we are at a juncture now where the market has had a tendency to surprise by continuing to rally further. We had one very typical failed bounce attempt over the past couple weeks, and now after yesterday we have a second try.

Technically the setup in the indices does not support much bullishness at all. We have a broken market, a failed bounce and now another light-volume spike to the upside. This is not a great setup for a lasting uptrend. But we'd be foolish to ignore how often in the past couple years this sort of ugly setup actually did produce a good low and a new uptrend.

While I'm definitely not inclined to take on a bullish posture here, I think it is important that will be cognizant of the market's inclination to not act in what would be considered "normal" fashion. In other words, we have to be mentally prepared just in case another "V"-shaped recovery does kick in.

There are a tremendous number of headwinds out there, and once we are past the Ben Bernanke Jackson Hole speech, there aren't many potential drivers as we enter the seasonally weakest time of the year. But this has been a bear killer of a market for 2½ years, and we need to give that fact a little respect.

We have a weak start this morning and we'll see if those dip-buyers have much energy, but technically the bounce yesterday was not very convincing and you have to embrace the fact that the old rules don't work very well to really believe this market is going to hold up.



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