A major advantage of a trend-following approach to the market is that some of the biggest gains come late in the cycle, as the anticipatory bears grow louder. When the logic of a market pullback or rest seems to be most compelling, stocks will often produce some of the best action.
We have seen a good example of this lately. Momentum in the major indices has slowed, but there has been a very persistent positive bias. The Nasdaq has been up eight days in a row now and so has the Russell 2000 ETF (IWM) but it's the small-caps that have been producing the best returns.
What happens as indices become increasingly extended is that market players start looking for individual stocks that may have better technical setups. The strength in those stocks draws in more speculative buyers -- and that produces outsized gains.
The current market is a great example of how stock picking late in the cycle can reward traders. There has been some unusually strong pockets of momentum -- and if you are in the right names, you are outperforming the indices.
The big danger of this action is that it tends to lead to complacency. The traders that are doing well scoff at the bears that keep warning that a major pullback is about to occur. Obviously, the bear's timing is very poor and since so many stocks are doing well, the bulls dismiss them as foolish.
At some point, this action is going to lead to a pullback or some corrective action, but as I keep writing, it isn't going to happen as long as there is the potential for positive trade news at any momentum. Last night, Reuters reported that negotiators are working on six broad agreements to address the most contentious argument in the trade negotiations. Agreements of this sort will obviously be a major market positive.
The key to effective trend following is to stay with the trend until the bitter end. Instead of trying to anticipate a turn, wait for a turn to actually occur before becoming bearish -- and then move very quickly. Extreme vigilance is needed to avoid giving back gains, but there can still be great potential for extra profits when everyone seems to think it is already very late in the cycle.
We have another mild open setting up this morning as the potential for good news prevents any aggressive selling.