Investors and traders should not own stocks now. If you waited until this correction became obvious, like the huge price drops that began July 27, 2011, then you missed several sell signals leading up to the drop. There have been numerous signs pointing to a market top, which I’ve been documenting since last May.

Two weeks ago, the news was riddled with statements like “the market is oversold,” “buy into the pullback,” and “look at valuations…everything is so cheap!” That is buying into a downtrend—a very dangerous strategy. The stock market is a cunning animal. It likes to let investors get away with this strategy the first few times, then when their confidence is high and their bet is bigger, down comes the guillotine.

Why is all the talk currently about “where the bottom might be”? All that does is tempt investors to guess. If I want to waste money guessing where the bottom lies, Vegas gives me better odds.

The media is also not helping here. We hear that “Warren Buffett is going shopping,” as if we should all follow Buffett’s “when prices fall, I buy more” advice. Have we not seen enough portfolios blow up in this decade? If you have 43 billion in cash (as Berkshire Hathaway reported in Q2), then you could withstand the potential drawdown as well as Buffett could. But how many of us have Buffett’s deep pockets? History has shown us that the market can drop a lot further then we expect, that bottom-fishing is extremely risky, and that it is possible to lose it all.

What investors need to do right now is consult their stock charts. Look at what leading indexes and leading stocks on charts are saying to help with market direction analysis. Charts do not have any opinions or predictions in them—only facts. Historically, we've found that when approximately 50% of leading stocks have topped, we are past the topping process and in a clear downtrend. We crossed that threshold on June 16th. As of today, we calculate that 68% of leading stocks have topped.

Now, the investors who got caught in this drop of the last few weeks are asking if this will be like 2008. In 2008, the S&P500 dropped 57% and the NASDAQ dropped 55%. I doubt we will get a repeat of that. But no one knows where it will finally bottom. All we know now is that it's going down in an accelerated fashion.

Going forward, in our shop, we will wait for the market environment to improve with confirmation of a new uptrend that holds. Until then, patience and capital preservation is our best friend.

Best Returns,

 

Scott O'Neil

President, MarketSmith Incorporated

Follow me on Twitter @WScottONeil

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