April 23, 2007

In this week's free newsletter, we'll take a look at an important factor for technical traders:  Letting the Charts Decide the Next Move.

With the market having just made a big run, some major indexes are now hitting new all-time highs (DJIA and RUT) while others are sitting at multi-year highs (S&P 500 and NAZ).  This inevitably brings out not only more casual investors who have a sudden interest in the market, but also the bears who are looking for some sort of market top.  My email inbox starts to collect spooky tales of ugly market corrections and the overconfidence of bulls, but that's nothing new.

It's very tempting to want to call a market top after a big move up, or to call a bottom after a big move down.  If you've traded for any length of time, you know just how hard it is do pull that off though.  There's a tremendous amount of luck involved in successfully calling a top or bottom, but if you try often enough you might get one right on occasion (it's all the other ones that hurt so badly!).  It's just natural for some to want to anticipate a reversal after a sustained move, but that doesn't necessarily make it a lucrative endeavor.

Predictions Can Be Painful

The trouble with trying to call a top or bottom is that even if you nail it, the transition may not be a smooth one.  The shift in sentiment might require some patience, and it very well might involve sitting through some painful rebound attempts while a topping process plays out.

For example, the bulls have enjoyed quite a nice uptrend since last summer, and every single dip since then has proven to be a good buying opportunity.  They aren't likely to walk away at the drop of a hat, so a few failed bounce attempts are more likely how a top would play out as they attempt to scoop up bargains but only find sellers lurking after weak bounces.  That wouldn't be a smooth transition from an uptrend to a downtrend, so just keep in mind that even if you're a perma-bear waiting for the financial world to end, it might not happen in a day or a week!

Staying Reactive

My personal preference (and the way we trade here at TheStockBandit.com) is to let the charts dictate the next move.  If lots of stocks start to break down from previously strong chart patterns, then I'll absolutely start taking more trades on the short side.  If strong stocks have merely pulled back to areas of support, then those may become buy candidates for me.

The charts will show you one way or another which way things are headed.  This approach has served me quite well to not get overly anticipatory or antsy in establishing positions in the opposite direction of the intermediate-term trend.  I try to watch the market with an unbiased opinion and stay open to anything that may happen, but at the moment the trend is up and cannot be ignored until there's technical evidence it is changing.

Sticking With the Trend

The most hard-core bears might disagree that staying net long is the higher-odds play at the moment, but if the trend is up why fight it?  The fact is real that trends can carry much farther than many expect, whether it's an uptrend or a downtrend.  Even in the midst of trends, the market (or stocks) can become short-term extended, but after some backing and filling takes place, things often revert right back to what was working before the hiccup.  So while the current market is short-term extended after a big recent run and stocks may be overdue for some resting or retracing, we have higher highs in place which means the uptrend is intact.

Here at TheStockBandit.com, we're letting the charts dictate our moves.  With so many stocks in uptrends, it is no wonder we're net long and finding more buy setups than short-sale candidates.  At some point, things will turn, but for now the charts are in favor of the bulls so we're sticking with them.  We don't make bold predictions about the market, we just observe what it's doing and find ways to extract some profits.

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Jeff White
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