Is This a Correction?

  • Posted by
  • on January 21st, 2011

WHO CARES?!  A trader’s job is 1) protect capital and 2)make money.  Call the market what you will, a chart making its final high looks about the same as the one that has months of highs ahead of it…labeling a market doesn’t help our cause.

Rant aside, there are some changes to note.  Most important is the dangerous plunge in participation.  I said in the comments here that I wasn’t concerned about the drop from 90% to 80% in number of stocks trading above their 10 week averages.  Why?  Because that adjustment has to happen to thwart too much enthusiasm.

Moving from 80% to 70% without a corresponding drop in the averages, however, is another story.  Losing a sector, or even two, is not a death sign for the market.  But once we move into 1 in 3 stocks drifting, it’s hard to view the market trend as expansionary.  And if it’s not expanding, it’s contracting.

On January 11, the $SPX closed at 1274 with 78% of stocks above their 10 Week MA.  At $SPX 1274 yesterday, that number was 70%, so I now view the intermediate term picture as contracting.  Confirming this is my candidate list.  For weeks, I’ve had 50+ candidates daily so it was pointless to pick names…risk was ON so it didn’t matter much what to buy.  Today?  A whopping 3, matching the paltry number of short candidates.

What does this mean?   It means we’ve entered a faders market.  I don’t believe the dynamics are in place for a large price drop, as the trend remains up as indicated by higher highs and higher lows.  But when a market(or stock) has a long run and then fails to embrace good news, it means longs don’t have quite the power they had and shorts shouldn’t be quite as fearful of fading highs.

Why not call it a correction?  Because that term is very personal and specific to our own timeframe.  Using my definition of a correction as a punch in the face of bulls, a short-term $IWM trader could call this a correction given that we moved over 3 daily ATR from Tuesday’s high to Thursday’s low.  But a punch doesn’t end the battle, it just gives the punchee a chance to see what he can absorb.  A longer-term bull?  Barely a flinch at 1 weekly ATR.  How we define a correction depends on who’s feeling the punch.

I see no benefit from jumping to a “correction” label…what, sell everything?  Wait for x% drop?  Why not just manage positions, and add new ones when setups arrive.  If the longer timeframe is destined to plunge, then yes our shorts will likely do more for us than our longs; the market will decide that outcome when it’s ready.

Last Friday’s “breakout” forced me to let go of weakened names.  I’ve yet to find new candidates for the cash but will prepare each day as though it is time to redeploy.  I’ve learned to let the first 2 days after a pivot go by without me, leaving me fresh to accept the market’s message starting on day 3…that day is today.  Now that the bears have (finally!) delivered a punch, let’s watch the next few days to see what types of setups emerge.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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