The market traded sharply higher on Monday, sending the Dow Jones Industrial Average (DJIA) and Russell 2000 to new all-time highs. Some of the big-cap technology names lagged a little as there was rotation out of growth names and into value, but there was broad strength with around 5,900 stocks advancing and 1,600 declining.
Markets that are this strong and hitting new highs don't just suddenly collapse. One of the easiest mistakes to make after a strong run is to look too hard for a dramatic reversal. Typically, the first weakness after a big move attracts dip buyers who missed out on the run and are anxious to put some capital to work. They will provide quick support and then the fear of missing out on more upside will kick in.
The great difficulty at this point is finding stocks that are not extended and offer prudent entry points. While hot groups such as electric vehicles may continue to run higher after the news that Tesla (TSLA) is being added to the S&P 500, the risk of pullbacks is extremely high when the hot money suddenly rushes to take some gains.
Momentum is an extremely strong force and it will often defeat overbought technical conditions. Just because a stock is extended doesn't mean it won't become more extended. Chasing strength can help you rack up some big gains, but if you are caught in a reversal the pullbacks can come fast and hard.
This is a constant dilemma for traders and the way to handle it largely will be a function of style. Shorter-term traders will find that taking partial profits into strength helps to reduce risk and provides flexibility for taking advantage of the inevitable pullbacks.
Although the DJIA is indicated lower here on Tuesday morning, the Nasdaq 100 is indicated higher on strength in Tesla due to an index addition and Amazon (AMZN) , which is going into the drugstore business. Walmart (WMT) is indicated higher on good earnings.
The good news is that even with overbought conditions this is a market for stock picking. There are some hot pockets of momentum, good dip-buying support and plenty of buying interest. Some downside at this point would be far more positive than negative.