I’m sure with all of the red on your screens today, you are probably already feeling cautious. However, I wanted to add some color to today’s action. So far this rally has been relatively forgiving, but we need to be careful here.

In a strong bull market environment, I would be using any pullback to add more shares to my favorite positions or buy stocks that I may have missed. However, the economic backdrop is not conducive to a strong bull market. The reactions to recent news events like the continuance of QE3, comments made by the Wal-Mart (WMT) and Caterpillar (CAT) management, and of course, the budget sequestering question in Washington, all expose how fragile this current uptrend is. Not to mention that a handful of prior leaders seem to be in a topping process, and there are now seven distribution days on the New York Composite Index (0NYC).

So, if you bought properly at the beginning of this rally, maybe you try to hold your best positions as long as you can, even if you have to trim down the size of some of them. Days like today require you to adjust your expectations for what the environment will give you; and adjust your portfolio management approach as well. Cutting losses shorter, and taking profits quicker, may help. The idea is to position for the possibility of more downside movement.

Hopefully we can shrug off this pullback and the market responds with a strong bounce back and this rally continues higher. It looks like the market may be trying to bounce into the close, but it’s too early to tell if it’s genuine. So you should not be in buying mode at this point, predicting that a bounce will materialize. React to what you are seeing on the index and your individual positions and react accordingly. If stocks begin to bounce and you can see demand (read: volume) over the next several days, the market may be okay. During next Tuesday’s webinar, I will provide a few examples of what a strong bounce should look like after a pullback. While waiting for a bounce, be prepared for another possible outcome; that this pullback could get worse and develop into a market in correction.

Best returns,

Scott O’Neil

President, MarketSmith Incorporated

Follow Scott O'Neil at Twitter.com/WScottOneil