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Should Investors Be Chasing Strength or Buying Weakness?

NEW YORK (Fabian Capital Management) -- The price action of the market in April has been a perfect example of the risk to reward of buying on weakness rather than chasing strength.

In the beginning of the month, the SPDR S&P 500 ETF (SPY) dipped below its 50-day moving average and appeared to be headed for much lower prices. Fears over further conflict between Russia and Ukraine along with weakness in momentum stocks was enough to push the markets below this key trend line. However, subsequent positive earnings announcements and geopolitical stabilization rapidly shifted the momentum back to the bulls.

We are now trading back to within spitting distance of all-time highs and many investors who are sitting on the sidelines are wondering where the next big move will be. Surprisingly enough, the iShares Transportation Average ETF (IYT) and Energy Select Sector SPDR (XLE) were two of the market leaders during this recent surge higher. Now both sectors have secured breakouts to new highs that warrant caution for investors that are thinking about chasing this strength.

In a liquidity-driven market, there are periods of time when stocks grind higher without giving you the benefit of a pullback to set up a more favorable entry point. Multiple days and weeks of positive returns make it agonizing to sit on the sidelines and patiently wait for a pullback or better trading opportunity.

However, that is oftentimes the best course of action when presented with the alternative of buying the highs and swiftly watching your hard-earned capital evaporate. The psychological nature of investing is that you want to add more exposure when things seem good, which is counterintuitive to buying low and selling high.

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