Keep Plenty of Powder Dry

 | Nov 10, 2011 | 3:30 PM EST  | Comments
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If you follow my column, you know that I am rarely fully invested. At the recent Oct. 4 lows, I was at my maximum exposure for the year, about 95% invested for my accounts at Rydex Mutual Funds, and that includes a short bond position and a long position in their High Income Fund for junk bonds.

Since then, on the bounce back up, I have pared back to be as little as 25% long. As of Wednesday's 400-point selloff in the Dow, I am back to a maximum of 45% invested in stocks and another 10% exposure to bonds (long junk -- high-yield corporates -- and short treasuries).

What is essential to my way of trading, however, is adhering to a cardinal rule: Always keep some powder dry, because you never know when the next opportunity might present itself.

I have never understood what it is about being 100% invested that so many money managers are so in love with. It's just idiotic. It's different if you're managing a fund for, say, Fidelity or Rydex because you have a contractual obligation to be close to fully invested all the time. That's why they pay you. But if you are running your own money and are only accountable to yourself and your customers, then why would you ever be fully invested? If the market suddenly drops 400 points, like it did yesterday, wouldn't it make sense to be in a position to add to your exposure at lower prices? That's what I do, but I can only do it if I have cash on the sidelines -- and I always do.

Wednesday I did a little buying of the S&P 500 (SPX) at the morning pricing of 1240.73 and added more at 1229.10 at the close. That gave me an average entry of about 1235 for an additional 10% exposure. I was hoping for a further drop to the Nov. 2 gap at 1218.28, but that hasn't happened so far.

Maybe we'll get the additional pullback to that gap on the next earth-shattering story out of Europe. If so, you can bet that I will be adding to my bullish bets. How much? Probably another 10% -- though it depends on what else is happening at that time, how the indicators are lining up and what the other indices are doing. I can assure you, what won't matter to me is the news. It never does.

SPX: Making a Higher Low This Morning
Source: optionsXpress

It was noteworthy that this morning's selloff from the initial pop found support where it had to, just above yesterday's lows of 1226.64, though it was low enough to fill the opening gap at 1229.10. From there, the SPX has bounced back above 1240.

While the Dow and SPX made higher lows than yesterday, note that the Russell 2000 made a marginally lower low for the move, just below 718, after bottoming yesterday at 718.86. The Nasdaq Composite also made a lower low this morning, taking out yesterday's lows by a good margin. So, once again, as we often see, a divergent lower low -- unconfirmed by the Dow and S&P 500 -- seems to be calling a near-term bottom.

Russell 2000: Lower Lows This Morning
Source: optionsXpress

A 33% pop in the Volatility Index (VIX) to Wednesday's high reading of 36.43 from Tuesday's low reading below 28 helped to call a short-term low. That suggested a low might be near, as did the McClellan Oscillator reading, as it backed off to the oversold side of neutral at -34 from Tuesday's overbought +118. Yes, you always want to have cash available for rainy days. But you also want to increase your cash positions as the market approaches or hits its upside targets, and as the market becomes increasingly overbought and over-believed, as it did at Tuesday's close.

VIX: Much More Bullish Above 36 Than Below 28
Source: optionsXpress

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