January 26th, 2010

Market Dominoes Beginning to Fall

Don’t know how many of you have focused on the fact that the market today is no higher than it was on October 16, the day I first started sounding the alarm about the possibility of a coming correction. In “Begin Pruning, Trimming and Weeding Your Portfolio“, I wrote

“now might actually be a good time to start “pruning” your portfolio. Begin trimming stocks you added during the run up since March-April that haven’t performed that well; if they have grown less than the market has while you’ve owned it, they probably won’t do better than the market in the future. Rebalance the portfolio by reducing the exposure in stocks that have significantly out performed the market and now represent too large a percentage of the portfolio.

Rather than thinking of these moves as “selling” the market, clearly a defensive move, view it as an offensive strategy, beginning to prepare for next leg. Funds generated through this “housecleaning” can either be held as cash or you can add to those remaining positions that are still working nicely and have room to grow (i.e., not bouncing up against resistance in the form of trendlines or moving averages).”

Granted, the past 3 months have been frustrating in their boredom and market indecision. But I believe we’re close to finding some resolution …. it’s on the downside.

Someone asked the other day how “the charts” can tell us if there will be a correction and how deep it will be? I answered that charts can’t predict but they can alert us to changes in direction of the market’s trend. It’s up to us to make our own decisions and act accordingly as any turn becomes more evident.

Our decisions become bolder as our assessment becomes more certain about a future outcomes. Each buy or sell decision is an incremental one. [I may sell all of a position in one shot but it is still incremental since it is only one of a number of stocks in a diversified portfolio. I would never sell everything and move into cash all at one time.]

As the market was bottoming last February-April, we become increasingly invested as it successfully crossed key hurdles. Today, as the market’s been peaking and moving into a correction, we see similar benchmarks as dominoes in a line that are about to fall (this chart is as of last Friday, January 22; since then the market has declined another 1.5%):

Are there any guidelines for managing cash (how much to sell, when) as the market begins to knock down those dominoes? I can’t give you firm rules but I can tell you what I will be doing. Since I have no idea of how far or how long the correction will take, I’m going to incrementally sell stock and adding to cash (getting ready for the next up leg sometime around Labor Day) as each domino falls:

  • move below the 100-day moving average, which currently corresponds to the 1095 bottom trendline of the Nov-Dec channel, would cause me to increase cash to 55%,
  • move below below the 1035 (the blue horizontal trendline of the October and November lows) would cause increase of cash to 75%
  • move below the 200-day moving average at around 100 would bring cash to near 85-90%
  • move below the 300-day moving average at around 930 and I would be all cash.

At that level … still hoping it doesn’t fall farther …. the neckline of the inverted head-and-shoulder bottom would be in striking distance. Crossing the neckline would mark the demise of this bull market.

How likely is any of this? Who knows, no one can predict. We’d like to know but don’t really have to since we will be taking incremental steps should additional dominoes fall.

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