Stock Market Course of Action

Stock Market Course of Action

The Trader's U E-Letter: Issue # 189

Thursday, May 25, 2006

Stock Market Course of Action: The Markets Look Sick Right Now - But You Don't Have To

by D.R. Barton, Jr., Chairman, Trader's U

This market is no fun for anyone who owns stocks in almost any sector.

Not only tech stocks (which are being annihilated), but the blue chips (faring a little better) and commodity stocks, and precious metals, and biotech and…

The list goes on.

The only people enjoying the last two weeks are the day traders who are literally feasting off of the added volatility (with daily ranges now 44% higher than they were on May 9).

But truth be told, you're not concerned about who has it going well right now. You'd rather have a plan. So, here's a stock market course of action for what types of decisions we should be making now. But first, let's toss in a needed bit of perspective.

How Bad Is This Market?

Let me be blunt - I think we've been spoiled by the U.S. markets (and the emerging markets) run-up over the past three years. The market has marched up with almost no significant pullbacks.

We've had it easy until now - this recent 12-day drop (though admittedly unpleasant) seems worse than it really is, because it's been so long since the market has delivered a real kick in the pants. Here's a quick chart showing how the major averages have fared since the recent highs:

American Exhanges Chart

The first thing to notice is that the weakest indexes - the Russell 2000 and the Nasdaq are just what we'd expect. I think the lone surprise is that the S&P 500 is "only" down 5%. It just seems a lot worse than that…

What To Do about Today's Markets? Don't Crawl Up the Staircase and Jump Out the Window

There are two reasons that this move seems so ugly. First, it has been relentless. We've had only a couple of minor "up" days during the drop. Second, the drop has occurred at a wickedly fast rate. In just 11 trading days, the market has given up all of the gains made during the first four and a half months of the year. Many market observers say that markets fall faster than they rise; that is certainly the case for this move. Jumping out the window, indeed!

On the day before the Dow made its high for the year, I warned against buying as that index approached its all-time highs. Overbought markets usually get rejected at their first attempt to break through significant resistance levels. Market sentiment levels were also getting to a fevered pitch: CNBC was dusting off the party hats and icing down the champagne in preparation for the break of the all-time high. That's a sure sign of a market topping action…

While we've had a quick pullback in the U.S. markets, emerging markets have taken an absolute beating. Russia was down 12% on Monday alone! Brazil is more than 25% off its yearly highs. So, while we've had a tough road over the past several weeks, we have to keep things in perspective.

Stock Market Course of Action: When They're Cryin', You Should be Buyin'; When They're Yellin', You Should be Sellin'

With the stock market in a steep pullback, what is a prudent course of action? Here are a few suggestions:

  • Check all of your stop losses and exit points. Market retracements are expected occurrences. There's no need to panic! Make sure your stop losses are in place and exit any positions that hit their stop loss points. If you don't hit the trailing stop that you set when you entered the trade or investment, then it's fine to stay the course.
  • If you don't have any current positions: Pullbacks create golden entry opportunities. However, there are some key risk factors in the market right now, so it's usually wise to wait for confirmation of a turnaround, instead of trying to pick a bottom.
  • If you think this "down" move is just the beginning of a bigger drop… Then you have a lot of compatriots in the technical and fundamental analysis communities (though this is by no means a consensus opinion). You can move your portfolio to a cash position or add "defensive stocks" to your portfolio. Sectors that do well in pullbacks - and have actually gone up in the last 11 days - include consumer staples, utilities and health care. Regardless of stock prices, folks still need groceries, electricity and doctors.

Don't let the market's ill temper make you sick. Stay on course with your plan and don't be hasty to pick the bottom of the move. Remember that there are big risk factors right now that can affect the U.S. markets, including the massive dumping of emerging market stocks and instability in big oil-producing countries like Iran and Nigeria. Pick spots to re-enter the market carefully, until clear technical indications signal a turnaround.

Great trading,

D.R.

The Chart of the Week

Chart of the Week

The Power of a Barron's Cover Story: Yahoo! (Nasdaq: YHOO) was the cover story in the most recent issue of Barron's, which hit mailboxes and newsstands on Saturday. While the broader market has continued to sell off, YHOO has enjoyed a three-day lift. Look for continued strength in the oversold stock.