No follow through

Yesterday’s low volume failed to trigger a follow through day for the market and the lack of conviction by buyers makes it appear the sharp rally was largely driven by short covering coming from bears who piled in on the short side last Thursday and Friday after the market cut under the 50dma.  Yesterday’s lack of meaningful follow through seems to be confirmed by today’s listless open and modest decline in the first couple hours of trading.

This back and forth action seems to be driven by a small group of eager and premature bull and bear traders who are jumping ahead of the market in anticipation of their predisposed view of the market.  But once this smaller group of traders blows their load on a position, the market quickly reverses because big money investors don’t get on board with the move.  And given the back and forth with no real net movement, it really seems like big money is taking a wait and see approach.  As CAN SLIM investors we follow big money’s lead and that means we should also be sitting tight.

Now the last couple weeks have highlighted the difference between selling early and holding through a correction.  No doubt sitting through 10-20-30 percent corrections in a stock is demoralizing and challenges a person to maintain their composure.  There are two ways to make money in this game, one is by trading and the other is by investing.  Obviously trading is short term in nature and the trader has to follow the market closely to time his buying and selling.  But on the other side of the spectrum is the investor who finds great stories to invest in and then holds for an extended period of time and sits through multiple price corrections.  Psychologically the big difference between the two approaches is the trader watches the market daily, hourly, and even by the minute because he has little conviction in his positions and is mostly catching technical and momentum waves.  This is contrasted with the investor who buys stocks he has a lot of conviction in and because of that he is comfortable ignoring price data for weeks or months at a time because he knows his fundamental analysis will hold up regardless of short-term market fluctuations.

The problem a lot of amateur traders/investors run into is blending these two strategies in incompatible ways.  This would be the investor who follows a stock’s price action daily and thus subjects himself to the emotional turmoil of watching his position go up and down and ultimately tempts himself to bailing out at the exact wrong time on inevitable weakness.  And the other side is the trader who doesn’t react to the market’s price moves and allows a small loss spiral out of control as he is waiting for it to recover.

The challenge for the CAN SLIM trader who is looking for the home run is we tend to follow the market closely and the method to our making money is riding waves of hot stocks.  This daily following of stock prices makes it a challenge to hold through pullbacks, as many people are experiencing right now.  This is why some experienced traders recommend having two completely different accounts segregated between trading and investing.  This allows you to follow your trading positions daily and largely ignore your long term investments, greatly reducing the emotional urge to sell your home runs at every pullback.  Just something to think about as you hone your approach to the markets.

As for the current market, we continue to hold in the trading range around the 50dma as big money is sitting on their hands.  Trading sideways is often supportive of these price levels, but the longer we sit at these levels makes a potential downward move larger in size.  A good analogy would be a coiled spring.  The longer we sit at one level, the more potential energy is wound into it and the larger the resulting move will be.

For the time being I tend to be slightly more bearish simply because of the strong rally we recently had and how this affected the expectations priced in the market.  The bar set for many of these companies is 30, 40 and 50 percent higher than it was last fall and that will make for an interesting earnings season.  The thing about the markets is it takes unexpected good new to drive it higher.