Bulls are not rolling over dead and they continue putting up a good fight. Yesterday the market rallied off of lows and closed in the upper end of the day’s range. Today the market gapped down at the open, but has since bounced strongly off of the lows. Is this resilience an encouraging sign, or a symptom of stubborn denial?
Often market participants are slow to identify shifts in the market’s personality as they cling to strategies that have been working. This is the classic case of chasing last year’s big winners hoping for a repeat performance, but this approach is often a day late and a dollar short as it fails to account for changing conditions and sentiment.
For the last 6-months, anyone who bought the dips made good money. And it seems a lot of traders are continuing with this same strategy as they try to bottom-pick this decline in anticipation of the next rally. But in the markets, things work until they don’t. And with every successful event, we move one step closer to the one that fails.
In the markets nothing is certain and to be successful we must anticipate and trade probabilities as we balance the risks and rewards. No doubt we could bounce higher from here, but given how long the previous rally was, we need to be on alert for a shift in market personality. Rather than chase the market, our goal should be to get in front of it as we anticipate these transitions. For example, a great time to close positions and take profits is when you feel on top of the world and start daydreaming about what you will buy with all your expected profits. And on the other side, when you have given up all hope and are convinced the market is about to plunge even further is when you need to start looking for stocks to buy.
Given the bounces over the last couple days, I expect we still have more room on the downside because the bulls and buy-the-dip crow has not been completely demoralized. Once we reach that point of maximum pain, they will all run for the exit, and that capitulation will signal the end of the sell-off. If we continue to get spooky headlines out of Europe, that point might not come until we break 1,300 on the S&P500. This is not a prediction, but simply listing one of several possible outcomes. And even if we fall down to 1,300, it might not be a straight line and we could saw-tooth our way lower as the buy-the-dip crowd continues to put up a fight.
As for leading stocks, they are dropping like flies as speculators are losing their appetite for risky investments. Some of these high-fliers were holding up well, only to get whacked days later. Little doubt these are exceptionally risky places to hideout in a correction. And even if some of them will make it through this, if you hold 5 stocks, will the one strong stock make up for the losses in the other four that implode? The deck is clearly stacked against retail investors in terms of knowledge, skill, experience, information, and resources, but the biggest and clearest advantage we have is our nimbleness. We can get in and out of positions in seconds, something big money is extremely envious of. If we fail to take advantage of our nimbleness, then we give up the only advantage we have in this game.