Stay Heavily in Cash

 | Nov 14, 2012 | 7:12 AM EST
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Merely through the constant need to ward off, one can become weak enough to be unable to defend oneself any longer. -- Friedrich Nietzsche

Monday was another disappointing day of action for a market that has been caught in a downtrend since the middle of September. The pace of the decline and the technical damage has accelerated following the election, but that hasn't had much impact on the serial bottom callers who keep trying to guess when this market might turn back up.

In the very early going this morning we have a little relief bounce developing as Cisco (CSCO) beat by 2 cents a share and issued in-line guidance. It wasn't a blow-out earnings report, but given how poor the third-quarter reporting season has been, it was a relief that they didn't disappoint. CSCO hasn't been a market leader for many years now, but its report is the last big one of the quarter. That could help the market make the psychological leap to fully price in what has been a very poor quarter of earnings.   

Once again this morning we have an oversold bounce effort. That always excites the hopeful bulls who are anxious to proclaim that the worst is over the moment we have any strength. They are already committed to the idea that this downtrend has gone on far too long, so they have to believe that any time we uptick it means that we have seen the lows. It is a dangerous way to think, but many investors live on a diet of hope and prayer. 

At some point that sort of thinking will work, but it usually is not a very good way to make money. Every time the bulls are wrong they just rack up more losses and have more ground to make up when the action does improve.

One very important thing to keep in mind when contemplating a downtrending market is that there is nothing more unproductive than having to make up losses. It is extremely important to keep your portfolio as close to its highs as possible. If you can do that, you will be far ahead of those who allow their accounts to deteriorate in a downtrend. Not only do you not have to recoup the money you lost, but you can immediately start making money when the market environment improves.

Unfortunately, traditional Wall Street preaches that we do just the opposite and stay highly invested even when the market is clearly downtrending. They will tell us that we will miss out when the big turn comes if we aren't fully invested into the teeth of a decline. If you have you keep your portfolio near its highs, you will be far ahead of these folks anyway and it won't matter at all if you don't catch a little bounce. They will simply be cutting their substantial losses while you will be looking to rack up some profits.

Bounces within downtrends always are a relief and are even a cause for celebration. If you are holding high levels of cash you might even feel like you are being left out, but in the vast majority of cases the investor holding cash is still in far better shape than the serial bottom caller who finally caught a break. Many of these folks will pretend that they timed the bottom with absolute precision and there will be no mention of all the losses they have to make up which were incurred in pursuit of timing a turn. 

The key to dealing with a downtrend market is to keep the right mindset. If you stay out of the way, as I've been advising lately, then there is little to worry about when we suffer further downside. In fact, it actually should make you more optimistic when the market continues to tumble, as the ensuing rally that is sure to eventually come will be even more robust.

Even if you are positioned defensively, this poor market action can take an emotional toll. It is very tiresome not to have good trading opportunities and for most market players the short side is a much tougher to play.

While it may not be very fun or exciting, the way to deal with this market is not complicated. We need to respect the downtrend and stay heavily in cash until conditions change. Play some short-term bounces if you are so inclined and be opportunistic, but don't be in any hurry to believe that the worst is over. When the market improves there will be plenty of time to make money and it will be even more profitable if you don't have to make up losses first.

The very early strength is already softening and it is looking like another challenging day.

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