Tuesday, March 5, 2013
When I first began my career as a trader, someone advised me to take a few moments at the end of each trading day to write down my thoughts on the day's activity.
It only had to be a few sentences – nothing too detailed or too poetic. The idea was just to capture how my head and my gut were responding to the action in the stock market.
I've been doing this for more than 30 years now. The result is stack upon stack upon stack of yellow notepads, 3x5 cards, backs of envelopes, hotel pamphlets, and assorted pieces of scrap paper all rubber-banded, stapled, and paper-clipped together and tossed into a few storage boxes.
My wife thinks it's just a big pile of junk taking up space in my home office. But it's actually the most valuable trading resource I have...
You see, that "pile of junk" contains my reactions – logical and emotional – to every market event of the past 30 years.
It covers the stock market crash of 1987 and the mini-crash in 1989. It details my reaction to the market's behavior as it sold off prior to the first Gulf War and how stocks exploded higher once the bombs started dropping. It covers the bond-market meltdown in 1994 and the dot-com mania in 1999. This "pile of junk" is the CliffsNotes version of three decades of stock market experience.
The benefit to these notes is more than just a walk down memory lane. They're blueprints for successful trading strategies. These notes let me review the times in my career when market conditions were similar to what we have on any given day, analyze my previous reactions, compare them to what I'm currently thinking, and develop a trading plan based on what would have worked best before.
For the past few weeks, I've been reviewing my notes from February 2011. That's the period of time that most resembles the wackiness we're seeing in the stock market so far this year.
In 2011, stocks started the year off in rally mode. The S&P 500 seemed to grind higher nearly every day. It didn't matter how overbought the conditions were or how many technical indicators were flashing warning signs. By mid-February, stocks were up 6.5%.
Then, just as it seemed the last bearish analyst had thrown in the towel and turned bullish, the selling started. By mid-March, the market had given back all its gains on the year. All the previous overbought conditions turned to oversold. And most of the bullish analysts had become bearish.
The same conditions exist today for a repeat performance. The S&P 500 is up more than 6% already this year. The price of copper – which typically leads the stock market – has turned lower, just as it did in February 2011. We're getting a series of wild daily swings in the stock market. And recently, the Volatility Index (the VIX) even exploded above its upper Bollinger Band and fell right back below it again... just as it did in late February 2011.
But it's not just the market action that is similar to 2011. My emotions are also striking a familiar chord. In my notes from that February, I wrote a lot about the stresses brought on by the relentless strength in the market... about how tough it was to wake up every morning and see the futures market higher... about the enormous pressure to find anything to buy just for the sake of getting into something.
I wrote about slamming my laptop shut when I got frustrated over misguided short sales, about banging my head on my keyboard, and about cursing out some "moron" analyst on CNBC who set a ridiculously high price target for the S&P 500 – all things I've also done recently.
So here's my point to all this...
I don't like the way the stock market looks right now. It's all too similar to 2011. Stocks are vulnerable to a quick decline – or possibly something worse.
I'm not saying it's time to sell everything and run for the hills. We survived the correction in early 2011 just fine. We'll make it through whatever is in store for us this time, too. In fact, any good pullback right now will likely set the stage for even higher stock prices a couple months from now – which is also what happened in 2011... But we need a good pullback first.
So if you're sitting on the sidelines and anxiously waiting for a chance to put some money to work in the stock market, stay seated just a while longer. There's no guarantee stocks won't just keep moving higher from here. But there are too many caution signs to ignore. Stocks will pull back at some point and give you a better opportunity to buy into the market.
And if you've been onboard the market rally since November, consider taking some chips off the table. Or at least tighten up your stops and protect your profits.
Best regards and good trading,
Last month, an "early warning sign" alerted Jeff to a potential pullback in the stock market. "Investors should pay attention," he writes. "Because when this indicator catches a cold, the stock market gets the flu. And recently, it sneezed."
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