Since March of last year we have enjoyed a sustained bull market rally. On Thursday and Friday we saw a fair amount of selling in the broad market, which now has us down year-to-date. A lot of this selling has been attributed to investor’s fears following rumors that China would be raising interest rates, comments from senators casting doubt over the re-appointment of Ben Bernanke, our President’s call to restrict big banks, and Barney Frank’s call to dismantle Freddie Mac and Fannie Mae. Without doubt, there is a lot to weigh on investors’ minds.
As traders we can pay attention to the macro-economic issues that confront us as a country and that impact upon our economy, but our real job is to pay attention to the market and manage risk. The image is a daily price chart of the S&P 500 following Friday’s market close. You will notice that Thursday’s price action took the S&P 500 directly to the 50-day moving average, which was then decisively breached on Friday. Our first Fib level is at 1,038, which is also a prior support level. If we breach this level the 200-day moving average will not be far away and will likely be the next bear target.
There is little doubt that the market is now correcting after a near 10-month market rally. The more difficult question is whether this will be a “normal” correction with a resumption of the upward trend or whether it is a harbinger of something more troubling.
Of course, no one knows the answer to this question although many will offer their opinion. Traders need to be more pragmatic, however. The trend is changing and whenever a change in trend takes place there is an opportunity to make and to lose money. If you have managed to maintain profitability during the past ten months, you do not necessarily need to make money during this corrective phase. The real objective is to maintain disciplined risk management and to minimize losses. In other words, let’s not give back the profits we have earned. That is the focus we have in the Trading Room.
For those of us who like to follow trends, it may be time to begin raising cash and adopt a “wait and see” posture. Maybe we move lower from here. Perhaps we simply consolidate for awhile before returning to the prior bullish trend. Maybe we will be range bound. I don’t know what direction the market will take, but I do know that if I am able to preserve capital during these transitional periods that I will be well situated to take advantage of the new trend once it emerges.
Christopher Smith
TheOptionClub.com