Securities Research Services

Thursday, September 14, 2006

Pavlov's Lesson

Over the past 18 or so months the market has become increasingly less volatile as upside breakouts have been stymied by sell programs and downside breakdowns failed to gain momentum. This period of time has trained trades, including admittedly us, to distrust large market moves and to bet firmly against them. This "lesson" the market has been teaching is very much like the stimuli that Pavlov used to train his dogs. This pavlovian response caused a lot of people to distrust this rally and as such the rally scaled a wall of worry unlike one we have seen in quite some time. Up until yesterday, puts were purchased on every dip causing subsequent covering to drive the prices higher and higher. Even so, we need to be careful here as the market is very close to reaching that point of recognition which will cause the tables to turn. As mentioned yesterday, the rally on Tuesday quite likely pushed back the expected correction another couple of weeks. This is not the time to lose our heads. That said, the market internals have been quite good over the past couple of days as breadth has improved immensely and stocks making new highs continues to grow. There should be some long side plays as long as good trailing stops are used to protect against any downside. For the time being, we are going to abstain from any further predictions and stick with what is right in front of us. We are also going to try and take a bit more risk since being too conservative has kept us from participating in this rally. What is in front of us today are a few decent long side set ups. Will they follow through? It's likely, but who knows for how long?

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