The smarter alternative to chasing prices higher

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On Thursday, the S&P 500 posted its biggest loss in two weeks. Of course, biggest is a relative term since we only gave up 0.35%. And the competition wasn’t all that fierce since there was only one other down day in that span.  But that is an indication of just how comfortable this climb higher has been.

Last fall’s plunge scared a lot of emotional investors out of the market, but now that fear is a distant memory. Long gone are predictions of global economic collapse. It been replaced by fear of being left behind. Last year’s fearful sellers turned into this year’s desperate buyers jumping on every dip in price, no matter how small. This desperate buying is why every bout of opening weakness has been gobbled up and we finished all these days higher.

But the thing to remember about emotional sellers is there are only so many of them. We saw that in late December when we ran out of sellers the day before Christmas. The market bottomed and prices rebounded, not because everything got better, but because we ran out of people willing to sell the fear.

And here we are nearly two months later. But instead of running out of sellers, we need to be worried about running out of buyers. Once all of last year’s fearful sellers finish buying back in, who is going to be the next buyer to keep chase prices higher?

While almost everyone loves calm climbs higher, rather than be lulled into complacency, we should be getting nervous about what happens next. The market finishes higher 53% of trading days, meaning it falls the other 47%. If a person believes in reversion to the mean, and they should, expect this string of up-days to be offset at some point by a string of down-days.

That said, claim the market is going to fall long enough and eventually you will be right. But in the market, we only make money when we get the timing right. Not only do we need to know what the market will do, we need to know when it will do it. And without a doubt, timing is the hardest part to get right.

But we don’t need to know exactly when something will happen to make money in the market. Trading successfully is about playing the odds and managing risk, not predicting the future.

Momentum is definitely higher and a trend is more likely to continue than reverse. But there always comes a point where it is no longer worth it. When the remaining reward shrinks and the risks grow.

Prices are quickly approaching major resistance above 2,800 and we haven’t had a meaningful pullback during this nearly 20% rally. How many points of profit are still above us? 30? 50? How many points of risk are between us and support? 180? Risking hundreds of points to make dozens hardly seems like a prudent trade.

The most nimble day traders can squeeze the last few dimes out of this rally, but the rest of us should definitely be growing defensive. Anyone still buying up here clearly doesn’t understand how markets work.

Don’t get me wrong, I’m definitely not bearish. But I don’t see any reason to be chasing prices higher after such a big run. While I don’t know exactly when the next pullback will happen, I do know it will fall through current levels. If we are returning to these prices at some point over the next few weeks, should we really feel pressured to buy today or risk getting left behind?

The biggest risk these late-buyers have is getting cold feet when prices inevitably dip under their buy point. Do they get scared again and bailout “before things get worse”? Sell last December’s plunge. Buy this February’s surge? Sell April’s dip? No wonder most people lose money in the market. If we want to make money, we should do the opposite. Buy when other people are fearful and sell when they are greedy.

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