Beware of Buying into a Downtrend

 

Since the Dow dropped as much as 370 points today the next round of commentary will probably be that today is a "Capitulation" Day. That implies that the market has bottomed and that now is a good time to buy stocks. In my opinion, that's completely wrong. The market is building momentum to the downside. It’s pretty hard to stop a train going 100 MPH.

 

The market may have a reactionary bounce from here; after all look at all those “great values.”  But will it be meaningful and lasting? How often have investors started initiating positions and been burned just a few days later?

 

There are still a number of factors that have me doubtful we will get a new significant uptrend soon. This cycle started back in March of 09”, so we are late in the cycle. About 60% of the leaders since the beginning of the cycle are broken. The last dozen of the very best are pulling back into their 50dma’s…again. In fact this reminds me of the kinds of stock chart patterns we were seeing in the first failed rally attempt during the summer last year. You don't usually begin a real rally without at least decent looking patterns from numerous market leaders, not defensive stocks. Earnings and sponsorship look good, but those are lagging indicators that tend to look best at the top. Look at the last two earnings seasons and how weak the market reaction was to such strong numbers. Finally I still believe it will be tough to gain traction without resolving the numerous domestic and international issues lingering over the market. The odds are that the inevitable reactionary bounce is a short reprieve on the way further down.

 

If the capitulation results in a new meaningful uptrend (and that is a big “if”), we are going to see that in the charts. Sitting on the sidelines does not mean we will tune out and miss the next rally. That’s why we are always on the lookout for new rallies to begin, and we wait for confirmation on or after the fourth day of the start of a new rally. We are looking for the rally to prove itself. The idea is to give up the first few points as a confirmation of strength that the rally is real.

 

If you are trying to pick a bottom here, take a look at past cycles and see how successful you’ve been at that game. A few may make it work but ask yourself, what you are trying to gain? A few points here and there? Or are you trying to build a portfolio of the best stocks that will result in a substantial year?

 

 

Best Returns,

 

Scott O’Neil

President, MarketSmith Incorporated

Follow on Twitter: http://twitter.com/#!/WScottONeil