Insiders Say to Take Protective Measures

This column was originally published on RealMoney on Aug. 23 at 12:38 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

My recent columns have relayed my increasingly bearish opinion about the near-term prospects for the indices. Unfortunately, that feeling only increased last week.

My now-enhanced insider-based market indicators have produced a sell signal that I'm not ignoring. I'm taking protective measures for the further market weakness my indicators show is likely, and even taking a bet against the indices. While I'm not all-out bearish here, I am applying discipline.

Applying Last Year's Lessons

I made the mistake last year of sitting too long while I lost hard-earned profits to a cruddy market patch. I already have shown more discipline during this recent leg up for the indices by taking profits in, among others:

• Titanium Metals(TIE Quote);
• Smith & Wesson(SWB Quote);
• Pentair(PNR Quote); and
• PSS World Medical(PSSI Quote).

I also cut my exposure to some positions that have become less-attractive plays for the short term, like VistaCare(VSTA Quote) and Alliance Gaming(AGI Quote). While I still like them longer term, slight disappointments recently weakened their charts' technicals. That could make them more vulnerable in the short term, should the market weaken more.

These actions have translated into a steady raising of cash as well. Over the past month, I have moved from having just 10% of my stock portfolio in cash to 50%, as of last week. That's extremely high for me.

I have not completely given up on deep-value investment theses that lack near-term price momentum, however. I still have buy ratings on a couple of micro-cap companies, and have even taken advantage of their stocks' present weakness to trickle more money into them. Only time will tell if I am making a mistake by sticking with these longer-term plays instead of getting out of them now and hoping for a better entry point. But given the more prudent moves I've made with the rest of my portfolio, I don't believe it's too risky to stay the course with selected deep-value plays.

Another mistake I made last year was being short the market too aggressively when the indices were testing downside support after falling for weeks. Hindsight shows that the indices were resilient at those very critical technical levels. However, a look back also shows the indices in something of a trading range, a pattern that I still believe is basically intact. Trying to make some money during the down legs is not wrong; it's just a whole lot trickier.

To try to catch weakness in the indices earlier this time, I have overlaid five technical and sentiment approaches to my insider-based market indicators, which I'll explain below. Using this combined approach, I finally am ready to take a bet against the indices again. For this purpose, I am buying (UCPIX Quote)ProFunds UltraShort Small-Cap Fund as a leveraged bet against the Russell 2000 Index. Specifically, the UltraShort ostensibly moves twice the inverse of the daily performance of the Russell 2000. So, if the Russell moves down by 1% on a given day, UltraShort should move up 2%. Of course, the opposite is true as well, and any readers interested in taking this approach need to determine how much of such a fund is appropriate for their portfolios.

Why So Glum?

Now that I've related my actions, let me explain why I've been growing increasingly bearish. The rolling four-week average of my insider buy/sell ratios (as plotted in the dark black line on the graph below) appears to be at an inflection point. The plot troughed at -230% for the week ending Aug. 5, and has risen to -188% in the latest week. A buy/sell ratio of 230% means that there have been 230% more companies with one sort of insider activity than the other. The negative sign indicates that it's the selling activity that is reigning supreme.

A Selling Inflection This type of activity reigns supreme

Click here for larger image.

Source: InsiderInsights.com