Bull-Market Geniuses Need New Plan

Now's the perfect time to shift gears and avoid a painful repeat of last year's mistakes. You may recall the first quarter of 2006, when the momentum market dried up and stocks fell for months on end. No, I'm not predicting a perfect replica of that sour price action, but the recent tape has flashed enough warning signs to get our full attention.

In particular, the Nasdaq Composite and Nasdaq 100 failed their breakouts during last week's selloff. This violation drops them back into broad trading ranges, just like the S&P 500 and Dow Industrials. The Nasdaq indices' inability to hold higher prices this January signals that buying pressure is drying up and setting the stage for a more challenging market environment.

On the flip side, I don't expect a big downturn to start anytime in the near future. There are just too many skeptics overeager to sell this market short, even though it's still trading relatively close to multiyear highs. This sets up ideal conditions for a sideways market that frustrates buyers and sellers for an extended period of time.

Sideways markets don't favor the momentum strategies that worked so well through the second half of 2006. If my email inbox is any indication, the majority of traders already are getting chopped up trying to ride uptrends that don't exist any longer. Of course, this isn't a surprise because the same thing happens at the end of every bull advance.

Bull-Market Genius

Making money is easy in easy markets. The challenge is to keep that capital when the market turns tail and stops going up. Unfortunately, most folks who make money in hot markets lose it all when the tape goes cold. This is just a fact of life. Hopefully, though, a select few will heed the warning signs and preserve equity through the upcoming tribulations.

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Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback; click here to send him an email. Also, click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by TheStreet.com.

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