Stay in the School of What Works Now

Don't expect a routine fourth quarter in the financial markets. The aftermath of Katrina will impact the American economy for months or years to come.

And don't assume this week's rally is the final response to the growing tragedy. As I discussed Tuesday, there are mechanical reasons we're seeing the market move higher right now. But this is a short-term reaction that may end soon. The long-term effects of this storm eventually could end the bull market.

But don't panic, because tough times will produce outstanding profits if you stay alert and shift your game with the changing tape.

Keep It Short Term

Let's start with the obvious: Now is a good time to close out your investments and become an opportunistic trader. Last week, I reviewed the positions in my long-term account and started to take profits on most of them. This blank slate lets me focus all my attention on the short-term action.

What's the best advice for dealing with the post-Katrina tape? Concentrate all your firepower in the school of what works now. Avoid long-term positions until the market establishes a sustained trend in either direction. That isn't what's happening this week.

The broad market hit yearly highs in midsummer and then sold off for several weeks. The indices started to recover after the hurricane and now are trading in the congestion pattern between those highs and lows.

Don't assume this rally will yield new highs. And realize that a failure below the summer peak could trigger a breakdown through the August lows. That selloff would mark continuation of the downtrend and the start of a decline that could reach the April lows quickly.

There's a growing assumption that the rally off the hurricane lows will yield an uptrend like we saw after Sept. 11, 2001. I don't believe this is going to happen. But the market will do its best to fool everyone until the real costs of Katrina sink deeply into the American psyche.

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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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