"Weakness of attitude becomes weakness of character." --Albert Einstein
The key to making money in the market is to trade in the direction of the trend. That sounds fairly simply, but the tricky part is knowing when the trend is ending so you can reposition.
Typically, markets don't suddenly shift from an uptrend one day to a downtrend the next. There is a transitional phase as traders struggle to deal with a market that is starting to show signs of stress. Sometimes these warning signs end up being nothing of consequence and we continue on our merry way. But sometimes they signal a major change in market character, and that is when we must be ready to act decisively.
Since Dec. 20, 2011, the most notable characteristic of this market has been exceptionally strong underlying support. Every time it pulled even, a few dip-buyers rush in and put it back at the highs. The S&P 500 hasn't had a day with a loss of more than 1% this year.
Even though the market is holding up well, the problem we encounter is that the dip-buyers are backing off and the sellers are showing more resolve, hitting the market harder when it spikes. We don't have any panic or a big rush for the exits, but over the past week the dip-buying has slowed, the spikes have begun reversing, and we actually had a close at the lows Wednesday. We were saved by Greek news late in the day Tuesday, but for most of the day, the dip-buyers hesitated.
Dip-buying is always a great strategy when the market is uptrending. As long it's going up, you can't lose if you buy the pullbacks and sell the strength. Because it works so well, dip-buyers don't generally give up quickly or easily, but eventually there comes a day when they buy the dip and there isn't a bounce. They suddenly find themselves trapped and they have to quickly exit to escape more severe losses. After that, the dip-buyers start getting cold feet and that is when the character of the market really changes.
That is what we have to look for now. We need to see if the bounces fizzle faster as the dip-buyers lose confidence -- or do we continue to hold up as underinvested bulls finally get the opportunity to put idle cash to work? There are signs that things are shifting, so we need to be more cautious.
Another important characteristic of the market to watch is its leadership. Apple (AAPL) has been leading the recent charge higher, and its sharp reversal Wednesday helped to create a major shift in the mood. There is good reason for that. According to SentimenTrader.com, when AAPL has reversed 1% after hitting new highs, the S&P 500 has declined an average of 5.2% at some point in the next month. AAPL is truly a market leader: when its action shifts, the implications affect the overall market.
There's gloom in the air this morning as the Greek mess seems to go on endlessly. We'll see what the dip-buyers do with early softness, but we definitely have to watch for a major change in market character.
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