Securities Research Services

Monday, May 28, 2007

Clarity Will Come and the Patient Will Profit

Thursday's selling was stemmed on Friday. The question here, was Thursday's sell off the start of something more, or was it just another bump in the road on the way higher?

There aren't a lot of clues to go on. Sentiment is mixed here as too many traders are long stocks and an equal number of traders are too short the indices. This translates to an overly bullish sentiment on individual stocks and an overly bearish sentiment on the indices.

Our scans don't help much. We are not finding many solid entry points to go long at. Very aggressive traders are quite likely to buy now that most stocks have pulled back to their 20-day averages. The problem with this strategy, from our perspective, is that stocks have moved too far, too fast to maintain this steep climb. In the past, under these types of conditions the failure rate has been very high.

Even so, we are in the last days of the month, where liquidity generally drives the market. And since this has been a market that has been floating higher on a sea of liquidity (as opposed to demand based on fundamentals) we may see prices try to move higher early in the week. The big question is, will sellers use rallies to aggressively sell, or will they step back out of the way and let prices drift higher on the fumes of liquidity?

It's difficult to say at this point. What is more clear is that this market is ripe for a larger correction and if they can move prices even higher, then we are only temporarily avoiding the inevitable and compounding the strength of the coming correction.

What is also clear is that being long in this market has led to a great deal of pain. Stocks have been teasing traders by setting up and then burning them as set ups fail. This is not the type of behavior that occurs in a strong market. Because of this, it's best not to be overly aggressive in this market. Keep position sizes small, and be patient as you wait for more clarity. That way, when clarity comes, and it will, you will have preserved your cash to take advantage of the opportunities.

The vast majority of traders get burned in these types of market conditions, when they should be conservative or sidelined altogether. Fighting in confusing markets ends up causing trading accounts to bleed money little by little and when real opportunities return they find themselves so poorly positioned that they can't take advantage.

No comments: