The wheel of change moves on, and those who were down go up and those who were up go down. --Jawaharlal Nehru
For most of 2012, this market has rewarded traders who simply stuck with the uptrend and didn't look too hard for negatives. Buy-and-hold has outperformed active trading as stocks moved straight up with little volatility.
But in the last two days, signs of change have been in the air. The Federal Reserve signaled that further quantitative easing may not come so easily, and European sovereign debt issues have started to flare up again. Suddenly, the fundamental negatives that have been ignored for so long are starting to matter and the technical condition of the market is changing.
As a trend follower, I am always watching carefully for a major change in the character of the market action. I want to stick with a trend as long as I can, but when it starts to shift, I want to adjust quickly and make sure that I protect my gains and precious capital.
The action we are seeing now causes me to embrace the idea that market conditions are shifting, and the recent uptrend can no longer be trusted. I'm not a growling grizzly looking for the market to crash, but I expect some struggles ahead, and that means taking a different approach in our quest for profits.
One of the easiest mistakes to make when playing a market top is expecting a straight down move. If you are too aggressive with shorts it is very easy to be caught in a squeeze. It is important to remember that the most aggressive upward spikes tend to occur within downtrends when folks are caught out of position. That can make for some good upside trading if you are fast and keep time frames short.
In dealing with a market that is undergoing a change in character, the most important thing is to adjust your thinking. Most of the damage that is done when the market turns is caused by folks who either are frozen into inaction or refuse to believe that anything has changed.
If you think of selling as the market weakens as just a form of insurance and not an irrevocable market position, it can help you to make some adjustments. You can always buy a stock back and if you end up paying a higher price, it is cheap insurance to guard against being caught in a major market turn.
The nice thing about a change in market character is that it leads to a new crop of opportunities as things reset and new winners and losers emerge. It is what makes trading the market so interesting and lucrative. The downside may cause some short-term pain but in the long run, it will be better for those of us who aggressively trade the market.
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