Too much of a good thing makes me nervous

Free After-Hours Analysis:

The S&P 500 popped 1.9% Tuesday after the monthly inflation report continued moderating and is now at levels that make future Fed rate hikes unlikely.

As has been the case over the last twelve months, this continues to be a less-bad-than-feared market. Whether it is uncontrollable inflation or Fed rate hikes strangling the economy, reality has turned out far less bad than doom-sayers have been claiming.

The stock market still faces plenty of economic risks and uncertainty, but at this point, the bulls have been far more right about our economic trajectory than the bears.

Lucky for readers, we were positioned well for Tuesday’s latest run-up in prices. As I wrote Monday evening:

Last Friday’s rebound was buyable, and we could add more Monday with stops already lifted up near Monday’s lows. I don’t see a big pile of near-term upside ahead of us, but when we can enter a trade in a low-risk way, we don’t need a lot of profit potential to make it a trade worth making.

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Without a doubt, I underestimated the big wave of buying that would wash over us less than 24 hours later, but it definitely pays well to be caught on the right side of this trade.

But now that stocks are 400 points above recent lows and within 2% of 52-week highs, this is the time to be getting defensive, not greedy. We’ve been right in a huge way, but that only matters if we are willing to lock in worthwhile profits when we have them.

We don’t need to totally abandon a trade that’s working this well, but we need to be spending far more time thinking about protecting these profits. That means lifting stops and even considering locking in some profits proactively.

Remember, no one can consistently pick tops, so don’t try. That leaves us with two choices: selling too early or holding too long. I prefer selling too early because cash is the best place to be when the next trading opportunity comes knocking. Anyone who holds too long risks giving everything away. Just ask all of the bears that were boasting about their profits two weeks ago. Bears that collected profits early are sitting pretty, while bears that held too long watched a great trade turn into a painful loss.

Stocks move in waves, and as good as this rebound looks, that’s exactly what makes me nervous. We don’t need to sell everything, but lift trailing stops to protect the majority of our profits and consider locking in some partial profits proactively. It is amazing how much easier it is to ride the next wave when we have a pile of profits in our pockets and a lot less exposure to the next wave of selling.

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