Saturday, January 5, 2008

State of the Market - Weekend Edition

Not a good way to end the week for the markets on Friday as all indexes except the Dow (-1.96%) were down more than 2% with the Nasdaq being hit with a loss of close to 4%. These losses came on very heavy volume. A disappointing jobs report that showed the unemployment rate jump to 5% was the main catalyst for the selling. If there was any doubt as to whether we are in the beginning stages of a bear market, I have to think those doubts were erased by the action Friday. Several indexes broke below important support levels, and there were many individual stocks that have been holding up the past few weeks take major tumbles today. IBD did indeed change their outlook to an official correction, and the market monitor continues to be in very bearish territory. Simply put, now is not the time to be investing on the long side of the market. Here are some important charts that point this out.

S&P 500


Russell 2000
Charts from Telechart 2007, Courtesy of Worden Brothers, Inc.

There were some leading stocks that held up OK all things considered on Friday, but many more that had technical damage done to them. When the leaders that have taken the market upward for so long start to fail, it is another clear sign that the market is in trouble. I also continue to see absolutely no attractive charts setting up, another reason to be bearish here.



Charts from Telechart 2007, Courtesy of Worden Brothers, Inc.

So where do we go from here? Obviously, from a longer-term perspective, it is hard to see the market not going lower over the next few months. On a short-term perspective, however, Friday was the Nasdaq's sixth straight down day, so we are getting oversold and the probability of the market having a reflex bounce sometime next week is increasing. We're not there yet however - if you have Telechart and view the T2108 indicator that shows stocks above their 40 day moving averages, we are not yet at the 20 level that has signaled bounces reliably well for the past year. We could still have a day or two of more selling before that reflex bounce occurs.

Charts from Telechart 2007, Courtesy of Worden Brothers, Inc.

I think the best way to handle the next few days(and maybe the next few months) is to sit on your hands and not do much of anything. If you are still long and have profits in stocks, you probably want to take those profits now. Certainly don't hold stocks that are showing losses. It is too late to short here, so don't even think about it unless you like taking huge risks. I will be looking to cover the shorts I have remaining soon. Wait until we get a bounce from oversold levels, which will likely bring many stocks back up to areas where the risk-reward ratio for shorts is much better. If you aren't comfortable with shorting, look into the inverse ETF's produced by Profunds. You can buy them in all accounts, including IRAs, and make money when the market goes down. I have owned the Financial Inverse ETF (SKF) for about a month now in IRA accounts and have made a nice gain on it. Again, I would wait for a market bounce to enter any of these ETFs. Bear markets do make it much more difficult to make money, but it is not impossible. Sometime in the next few days, I hope to write about how I go about looking for short candidates.

On a personal note, I do feel a bit more confident in my ability as a trader after the market break. There is always a chance the market does a 180 here and rallies for the next year, but I really can't see that happening. I have been bearish for about two months now, but I was continually frustrated during this period as I expected the market to finally go down after a four or five year bull run. I just saw too many ugly charts, too many weak volume rallies, and couldn't understand why the market kept holding up. I have read that market tops are much harder to recognize because they take much longer to occur, and I think I understand this a little better now. I was not trading back in the early part of this decade, so I missed the bubble and the bear market that followed. And since 2003, we have had hardly any meaningful corrections (over 10%) in the market overall. So never being through a bear-type market, I was expecting just one big downswing. I didn't realize it takes a lot of time and a lot of fake moves before the real down move starts. Perhaps this is the real downmove, or perhaps we are still in store for some fakeouts, but I do feel good that I could recognize some of the things happening and have an opinion that turned out to be correct. I am still not where I need to be as a trader, but perhaps I am learning and getting better.

Good luck next week, and remember that if we do continue to move lower here, it is only getting us closer to the start of the next bull market with new stocks making huge gains. Corrections are a necessary part of the market cycle, and there is still money to be made during them. Use this time to improve your techniques, study the big winners from the past year, and work to make yourself a better trader. Right now, I am trying to develop a way to recognize stocks that are likely candidates to put in strong bounces when the market is oversold. I don't know if I will come up with a perfect system for this, but I will continue to work on it and hopefully have one more tool at my disposal for making some money. If I can develop something worthwhile, I will share it with you.

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