It's To Your Advantage To Heed Risk

Today we would like to address the reasons why risk is such an important consideration to take before putting money to work in the market and where the advantages are best.

Over the past few weeks we have noted that risk has been extremely high. This has been represented in the SRS Risk Assessment Meter. But today, let's take a look at precisely why risk is high and why it is not a good idea to have much, if any cash working in this market. We will also take a look at what a low risk situation looks like and why putting cash to work has a better chance of success when risk is lower than it is now.

As you can see on the chart below, the SPY, which we are using as a representative of the broader market, is currently trading at its pivot point:

After putting in a panic low in late January, the market has pulled back to the pivot point where it is struggling to make a higher low. Due to the fact that sentiment is extremely overly bearish and due to the fact that technical indicators point to a low level of buying here, not to mention the fact that the Fed continues to be a factor, odds slightly favor a move back up to the falling 50-week average.

The key word here is "slightly."

Buying is extremely weak at current levels and volume has been shrinking. While odds slightly favor a rally back up to strong resistance, a breakdown below last week's lows has some potential as well.

If the market can muster a rally, the number of stocks that will come along for the ride is likely to be small since the market is in a major downtrend here and any upside would only be a dead cat bounce against the larger trend. As such, trades taken in this area are prone to a high failure rate.

Where Risk Is Low:

One of two things will happen over the next week or two, which will give us a better trading opportunity than currently exists. The market will either break down and give us a good low risk buy entry as panic spikes once again, or the market will weakly rally into overhead resistance, giving us a high risk shorting opportunity.

The lesson here is that if you refuse to put good money to work during times of high risk and patiently wait for prices to move into the zones where risk is much lower you will not only avoid letting your trading account get chewed up by too many stop outs, but you will easily outperform the averages and more than likely blow away the star fund managers who feel obligated to have their money working in the market at all times.

Independent Trader Advantages:

As small, independent traders, you have an advantage over the big money managers in that you don't have to have your money working during times of high risk and you have the ability to move in and out of positions quickly as conditions change. This is an outstanding advantage that most traders fail to use. We strongly urge that you use this advantage as doing so can make the difference between below average returns or results that would make a Buffet proud.

Explanation:

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With sentiment bearish and with prices near support levels, we are looking for stocks to rally back up from near current levels. As noted above, it's hard to justify buying when all major moving averages are still pointed down, but we wouldn't want to be very short here either. In fact, it might be a good idea to put a toe or two in the water (using tight stops of course) here in some of the stronger areas of the market.

Outlook:

The rebound rally back up to the 40- and 50-week averages we have been discussing will likely occur sooner rather than later. Until prices regress back to their mean, risk of whip saw will remain high and position sizes should be kept small.