Having studied other young market rallies, I know that many have a similar look and feel. So I’ve been studying the NASDAQ chart from October 2010 as a possible historical precedent for the market’s current action. Unlike a court of law, I never base decisions solely on a precedent, but history can sometimes provide a useful context for current market behavior that supports or calls into question my market interpretation.

 

In September 2010 we had just emerged from a four-month market correction that contained several tempting rally attempts that ultimately failed. So after being fooled three times, many investors were reluctant to re-enter, and volume was pretty light. Four weeks into the rally (October 2010), it was clear that the rally was much more convincing than what we were given previously, and many leading stocks were breaking out.

 

I now find myself in a similar situation: lightly invested after a nice four week run. I am currently 26% invested, but given the subtle strength of the market, I wish I were invested 10% more. I would simply add 10% here, but I know the market tends to pull in after a strong move up that lasts several weeks. So I turn to the precedent for guidance, and it gives me some optimism. In 2010, the market was so strong it stuttered only slightly before continuing to run for another four weeks. So while my gut tells me a pullback may be in the cards, I shouldn’t let that stop me from buying because this market could be so strong, no pullback materializes.

 

I should mention that precedents work really well, until they don’t. So when the market begins to deviate from the precedent, I will no longer use it. If we get hit with negative news and the market reverses direction, for example, all bets are off.

 

Another lesson from this precedent is that investors can’t stand still when the market environment changes. Don’t let market weakness affect you after it is over. Currently there are 40-50 stocks out there with decent-looking setups to go long. The market action has been constructive, and we haven’t seen significant distribution. So I’m looking to wade in deeper. If you go back and read my last blog, you can get an idea for how I’m doing that. I’m still being disciplined and precise with my entries and keeping my expectations realistic. Patience is big here.

 

One last lesson: Notice that those who began buying late or adding shares late (after mid-October 2010) most likely got caught in the November pullback. So the key is to increase your percent invested by purchasing stocks that are just now beginning to break out or pulling back into support. While wading in, it is most important to avoid extended stocks and keep that average cost low. “Defense first” is a great mantra to invest by, but you can still take some shots and get some points on the board.

 

Best Returns,

 

Scott O’Neil

President, MarketSmith Incorporated

Follow Scott O'Neil at Twitter.com/WScottOneil