One thing experience has taught me repeatedly is that it’s best to operate in the stock market in increments. When deciding to buy or sell stock, I am always on the lookout for signs that I should be increasing or decreasing my exposure.

 

Initiating positions during a new market uptrend always begins with the same sign, a Follow-Through Day (FTD). The most recent FTD occurred on the S&P500 back on 4/25/2012, which gave me the sign the trend had changed and I could begin buying. I had been out of the market since it began showing signs of topping (detailed in my last blog on 4/4/2012). On a FTD, I do not plunge 100% back into the market. Instead, I begin incrementally initiating positions based on the strength seen in the market. Marginal FTDs often lead to marginal results, so 4/25 I was buying very lightly at first. Since establishing my initial positions, I have been on the lookout for further indications as to whether I should be increasing or decreasing my exposure at this point.

 

So far, getting a read on the strength of this rally has been tricky. It involves evaluating the leading indices, leading stocks, and the stocks in my portfolio. Last week there were initially some lifts on the indices and in leading stocks. But lately reversals and outright blowups have also been occurring so that the strength of leading stocks is now about mixed. At this point, the most important indicator is the equity in your portfolio. If you aren’t making progress, do not move in any deeper. Right now I am resisting the temptation to buy more until my initial decisions prove correct.

 

While I wait, I am watching for additional clues as to where this market is heading. It’s good to see stock behaving favorably to response to earnings, like Whole Foods Market (WFM) and Liquidity Services Inc (LQDT). But leaders are not escaping unscathed. Today it was the Oil and Semiconductor stocks that got hit. Before that, it was stocks like Ubiquity Networks (UBNT) and Herbalife Ltd. (HLF) getting nailed on earnings announcements. In the back of my mind, I know that as more stocks get blown up, at some point, one of mine could be next.

 

All of this comes down to measuring the risk in the market and balancing your exposure against the potential risks. Today’s action exposed how fragile this market really is. But discipline with your rules and incremental precision on your transactions will protect you from mistakes.

 

 

Remember this is all for education purposes only. Look at what I’m saying and match it up with a chart. In the end, everyone must do their own research and make decisions that are appropriate for their portfolio.

 

Best Returns,

 

Scott O’Neil

President, MarketSmith Incorporated.

Follow Scott O'Neil at Twitter.com/WScottOneil