CLOUDY WITH A CHANCE OF FURBALLS
To think of oneself as a patient market participant is a sign of maturity as an investor. Most of those who are just becoming acclimated to the various nuances of the financial markets are quick to jump at the first shadow. Many of those, in fact, who attempt to create wealth through financial speculation of any sort are plagued with a mindset of risk AVOIDANCE instead of risk CONTROL.
Avoiding risk is what short-term traders attempt to do on a daily basis with an erroneous mindset that not being involved heavily overnight or keeping tight stops is a competent form of risk control. Instead they wind up getting minced through the teeth of the market as a result of stops that are too tight, markets that are too efficient and patterns that stopped working when Iomega was the "it" stock. In my article "An Ode To The Short-Term Trader" I went over all of the obstacles faced by the short-term trading community in the current market environment. It seemed to resonate as it is the most popular article I have written on this site in the two years it has been up.
Risk control is another animal entirely. It does not involve setting arbitrary stops or being overly-conservative to a fault. It simply involves having every aspect of risk in the portfolio planned out. You know where your allocation will be if the Dow is at 13,000. You know where your allocation will be if the S&P is at 1600. You know how to respond to a 5 percent drawdown in equity. You also know where you will be if it gets to 10 percent or more. A road map of risk that controls risk and DOES NOT avoid it. After all, we are in the markets to make real returns. By that, I don't mean inflation adjusted returns, I mean REAL returns. Controlling risk is how you get there. Avoiding risk is not.
With that soliloquy out of the way, I can now focus on the real purpose of this posting . While the Dow did post a very positive close on a technical basis, we have now moved to a point where risk/reward has shifted to the downside for the overall market. This does not at all mean that a ferocious pullback is imminent. It simply means that the upside bias that has become a comfortable backdrop for the market early into 2013 will start getting a little bit uncomfortable from here.
In my posting on January 3rd (The Road Map For 2013: Same Rules Different Year), I determined the road map for 2013 would continue to follow the trajectory points that have been capping the upside of the market for the past few years. Anything too far below the trajectory equals a buying opportunity. Anything above the trajectory equals an opportunity to trim exposure. We are now getting to the point we are moving too far into a turbulence zone for the markets as the chart below demonstrates:
click chart to enlarge
DOW
This assessment leaves me with nothing else to do but sit on my hands. The portfolios are at roughly 85% invested on the long side. I believe the larger holdings have enough momentum to outperform a sideways market.
If I am wrong, I will know quickly enough to make the necessary adjustments.
Risk control.
