Thursday, January 31, 2008

State of the Market - 1/31/08

A lot of volatility today, as the markets opened much lower, continuing the negative action from Thursday’s close. However, this gap down was quickly bought, and stock rose through the rest of the morning. Gains continued in the afternoon, and all indexes closed near their highs for the day and finished up at least 1.5%, with the small caps finishing up an impressive 2.5%. The gains were on higher volume, and as an IBD follower, I believe this will qualify as a follow-through day on the seventh day of this rally attempt. I don’t know about anyone else, but right now this market’s swings are making it virtually impossible to trade well, unless you are an expert day-trader. I wish I would have followed my own advice of a week or so ago when I said it is best to sit out for a little while until the market paints a clearer picture, because if you don’t, you’re likely to get chewed up and spit out. Too bad for me I was not smart enough to do that.

With the follow-through day, the market outlook is now bullish and shorting is probably not the right play anymore. However, that does not mean it’s a great time to just buy whatever you want and make tons of money. This is what IBD said last night about the state of individual stocks right now:

Even if the market manages to sustain its current attempted rally, there would be little to buy. Most fundamentally strong stocks are in various stages of technical disrepair. It might take months before sound price bases emerge.”

I still have major doubts about how farther we go from here and I will just be sitting on the sidelines over the next few days. Perhaps more stocks will quickly set up in nice-looking bases and everything really will be OK. I have not done my scans for today yet, but I did not notice any new stocks breaking out today on IBD’s Stocks on the Move (MA was a maybe but closed near its lows), and I always remember this passage from William O’Neil’s shorting book:

“You should be alert to follow-through days that occur without fundamentally sound stocks staging strong breakouts from sound base formations. Often a questionable follow-through can be indentified by a dearth of such breakouts which results in a noticeable lack of leadership. A sound follow-through day is generally accompanied by strong breakouts among a number of fundamentally sound stocks, so when this doesn’t happen, be alert to the possibility that the follow-through may likely fail.”

I realize you rarely get what you want in the market, and I know bear markets and corrections kind of suck to sit through, but I think the worst thing that could happen right now is for us to continue to go up here and put in a decent run. Charts continue to look awful and have had way too much technical damage done to them. We need probably a few months of lower prices and lower volatility to start forming the nice bases that can lead to a truly new bull market. If this follow-through doesn’t fail quickly, the moves in individual stocks will not be the rocket moves you see at the start of a typical bull market. We’re not going to see the TASR’s or TZOO’s or NTRI’s unless we really go through the process of wringing out all of the weak hands and letting new leaders come to the top. I am sure a lot of people made a lot of money buying banks and real estate stocks this past week – more power to them. I can’t bottom fish like that – it is not my style and has been proven to not be as effective as investing in small companies that are growing in a strong manner. I guess the only thing I can do is wait this bounce out, see where we go, and be patient.

This was not a fun morning for me as I watched the stocks I was well positioned in yesterday but let myself be taken out of gap down hard at the open. I will learn – that is all you can do when you make a mistake. I don’t know that I would have covered then anyway. Looking back to yesterday, my real mistake was that I didn’t follow my stop loss rules strictly. I should have covered some of these on Monday or Tuesday for a small loss and then looked to get back in later if the opportunity presented itself. I held because I thought I was right about how the market would react to the Fed and really didn’t want to cover these shorts and then watch them do exactly what I thought they would do, so I let the losses go. My ego took over and wouldn’t let me admit I may have been a few days off in my timing. What would be wrong with being a few days off? Absolutely nothing. I would have taken a few small losses and would possibly have reentered those shorts at the end of the day yesterday when I got confirmation that my thoughts were probably right. By not covering earlier, I let losses get to a point that I had to cover at the most inopportune time – near the peak of yesterday’s rally – because they were just getting too big. My fear of taking a bigger loss overtook my fear of missing out – basically I finally admitted I was probably wrong, but again at the most inopportune time. If I would have just done it two days earlier and taken my ego out of it, I would likely be sitting OK today.

I also made a mistake by trying to make up for those mistakes too quickly. I made two trades this morning and both turned out poorly, as well as the two I put on at the end of the day yesterday. It is almost like poker players going on what they call “tilt”, when their emotions get the best of them and they begin to make bad decisions because of it. I wrote this thought down in my trading diary when I entered these trades this morning, and I am realizing now that it was probably true.

Although I am still mad at myself, I will get over it and move on. I keep thinking about what Mark Douglas wrote about in his book, “The Disciplined Trader”. It is important to learn from mistakes, but do not let them affect you. The situation yesterday simply shows me that I did not have all of the requisite skills I needed at that moment to do what was correct, and that I still need to develop those skills. There is really no reason to dwell on it, get upset about it, or let it linger in your psyche. Learn from it, move on, and try to improve and do better next time. Being a perfectionist(like me) is not a great trait for a trader to have, and that is something that I have to deal with. I will be fine in a few days, and will hopefully improve myself and become a better trader from this experience.

I won’t be posting for the next few days, because after the action of this week, I think I need to take a break for at least a few days and just stop trading. I am beginning to know when I am not trading well and I feel that way now. I have had several losses in a row with only one decent win. If I continue, I will press (I see myself already doing that) and likely make even more mistakes. I wish I would have stuck to my original plan of staying out of the market for a while after trading so well in early January. I still get way too impatient and sometimes think that I can make opportunities happen instead of letting them happen. So I think staying away for a few days is best right now, and maybe by the time I come back, the market will have decided what it wants to do for real and I will be in a better frame of mind. I don’t know what to expect from tomorrow’s action, other to say it will likely be unpredictable. Good luck over the next few days.

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