Good trades and low-risk investments are drying up after the seven-week rally, which is no surprise considering the vertical trajectory of the uptick or the lack of orderly pullbacks. It's a tough spot if you're loaded up on the long side and exposed to the vagaries of an overbought market. But there's no need to panic because there's still time to protect your hard-earned profits.
Fresh buy signals should come if we retrace at 38% to 50% of the post-February uptrend. That correction, if it occurs, should take at least six weeks and encourage bears to growl loudly after their long hibernation. Keep in mind that dip-buying strategies have worked poorly in the last year because every downturn has turned into a full-scale selloff.
So we won't know if it's really different this time until support holds up and the market recovers to new highs. That uncertainty makes the next downturn a major challenge because healthy pullbacks and unhealthy downtrends look the same until hidden buyers find their levels and come off the sidelines.
Are you prepared to watch your positions drop five, 10 or 15 points in the next few months? If not, now is the time to take some money off the table or pick up options protection to carry you through a corrective phase. In addition, you need to find the price level on each position where you're no longer willing to hold on and take the pain.
In most cases, this exit door should be located above your original entry so you can pocket a little money for all your efforts. The best plan after you've found this magic number is to place a stop order at the level right away so you're not tempted to hold on if the stock drops toward it a week or a month from now. Then let the market gods decide the fate of those investments.
Use the freed-up cash to make a laundry list of stocks you'd like to own at lower levels. Be conservative in your pricing methodology and consider just how far your favorite stocks might drop in an adverse market environment. As a technician, I seek out unfilled gaps to find my entry targets, with the understanding that most gaps will eventually get filled.
A corrective period will make newly minted bulls uncomfortable and force them to question their faith in the brave new world that began in early March. I recommend you keep the big index numbers in front of your nose at all times. This will lower the emotional fire and give you the courage to hang on when negative sentiment hits the ticker tape.
Fibonacci retracements, weekly charts and big round numbers are my favorite prognostic tools when markets pull back, and we don't know when the selling pressure is going to ease up. For example, if the
S&P Depository Receipts
turns tail right here and enters a correction, I'll be watching three big numbers where buyers might come off the sidelines.
The 80 level, which corresponds with 800 on the
, marks an obvious line in the sand where bulls need to step up and show their strength. Right now this level has converged with the 38% retracement of the March-into-April rally. Perhaps this isn't a coincidence and a downturn will be drawn into that price zone like a moth into the flame.
The 62% retracement level near 75 is also interesting because it converges with the November low that was broken in late February. The index remounted that price level on March 12 but has never tested new support. That omission could make it an attractive target during the next downturn.
Weekly price action shows a loss of momentum in recent weeks right after the fund rallied above the 20-week moving average. The weekly Stochastics has pulled into overbought territory and is in danger of rolling over on a relatively minor downturn. The Bollinger Bands are now moving sideways, pointing to a broad trading range as opposed to a well-established uptrend.
Every correction since 2003 has found a way to tag the bottom of the weekly Bollinger Band, which is a scary thought because the bottom band is very close to the bear market low. The good news is that the band will move higher during a correction as it responds to the shift in price direction.
The worst thing that investors and long-term traders can do right now is ignore the risk of an overbought market sitting near major resistance. That casual attitude has cost market players dearly in the last two years. In other words, it's the wrong time to turn a blind eye to the ugly lessons of this bear market and resume an outdated buy-and-hold mentality.
Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.
At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.
Alan Farley is a private trader and publisher of
Hard Right Edge
, a comprehensive resource for trader education, technical analysis, and short-term trading techniques. He is also the author of
, a premium product that outlines his charts and analysis. Farley has also been featured in
. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.
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