Lessons from Churchill and Old Traders

Churchill was a man who believed in making only loose commitments to the affairs of other countries. He believed that treaties should be made only if there was a benefit to England and that they should be broken if that benefit was lost. He once said “A fanatic is one who can't change his mind and won't change the subject.”

The same should be true in the stock market. It is important to never commit so strongly to an idea that it blinds you when something changes.

We have been very bearish on the market over the past few weeks due to the reasons that we have outlined in past reports. There are a couple of developments that we believe make it necessary to move from the bearish camp slightly into the neutral camp.

Let’s review what is bearish about this market and what is bullish about it:

First, the weekly charts are in a downtrend, having firmly reversed the uptrend which started late last summer. This is bearish and it is compelling.

Second, most stocks and most indices remain under their 20- and 50-day averages. This is also very bearish.

Nevertheless, when sentiment is too bearish, many times stocks just won’t go down. The market almost always goes out of its way to cause the most pain to the greatest number of people. For three weeks in a row now the put:call ratio has been almost 2:1 bearish. This is the longest streak of bearish sentiment that has occurred this millennium. We are very uncomfortable when we are in agreement with the crowd for this period of time. To be sure, this overly bearish sentiment reading is bullish for if the market puts just a little pain to the bearish positions opened, a short covering rally could turn into a market that once again is climbing a wall of worry.

Lastly, the daily charts on many stocks and the major indices have carved out double bottom patterns. The QQQQ, SPY and DIA have all bounced off their 200-day averages twice now. The pattern is not yet confirmed, but if the QQQQ closes over yesterday’s high on equal or greater volume to Monday’s trading, then it will confirm a double bottom. The SPY and DIA still have some work to do.

We do not think these developments are a reason to run out and start buying stocks madly. What they are telling us is that risk is very high here and that stops should be tightened up.

In our scans we are seeing some stocks moving up on what could be interpreted as short squeezes, but we are not yet seeing the type of set ups that compel us to get any shorter and certainly not the type that compel us to jump ship and go long.

Bold traders could certainly take some risks in this market, but an old trader once said “There are bold traders and there are old traders, but there is no such thing as an old, bold trader.”

We think there is wisdom in both Churchill’s and that old trader’s words.