Tuesday, March 10, 2009
Ever heard "The trend is your friend"? This market cliché implies you should stick to buying stocks in a bull market and shorting stocks in a bear market. For the most part, that's good advice.
But every once in a while, stocks move violently in the opposite direction of the trend and impose a world of hurt on market neophytes who aren't prepared to handle a correction. We are on the verge of just such a move.
Clearly, stocks are in a bear market. I told you as much way back in January 2008. And the bear market has farther to fall. I expect the S&P 500 will drop below 600 later this year before this bear heads back into the cave for hibernation. But in the very short term, stocks are poised for one heck of a rally. And holding short positions through such a move could be catastrophic.
It won't be the first time we've seen such a move. We've seen a handful of one- and two-day "wonder" rallies in the past year. All of them occurred just as the market looked like it was falling over a cliff, and all of them caught unsuspecting short sellers leaning too far in the wrong direction.
The last such rally happened at the November lows. The Dow closed at 7,552 on November 20, 2008. Four trading days later, it was at 8,829. That's a gain of nearly 1,300 points, or roughly 17%. By the look of things, the market is setting up for a similar move right now.
Yes, the S&P 500 dropped another 1% yesterday – it's down 25% on the year so far. But in a rare feat of outperformance, the financial sector actually gained 1.3% in Monday's trading action.
The financial sector ETF (XLF) traded higher for most of the day and actually closed up $0.08. No, that's not a huge move – especially given how far it has fallen recently. But throwing a few breadcrumbs to a starving man will keep him alive a while longer. And yesterday's action in the financial sector may do the same thing for the stock market.
Financial stocks often lead the market. It is the trouble in the banking sector that has caused the whole stock market to collapse over the past year. While one day doesn't make a trend, the sector's strong performance yesterday may be the first sign of good things to come – at least for the next few weeks or so.
So if you're playing the short side, be careful. The rubber band is stretched way too far to the downside and a snapback can happen anytime. If you're trading from the long side, you may see a very fast move higher, and it could generate large gains in a short time. But be careful. The bear is not yet done with his feast.
He'll be back in a few weeks to pick at the scraps.
Best regards and good trading,
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