WRATH OF THE MATH
There isn't much to do in this market. Hopefully, you allocated to the long side sometime ago and are enjoying the current gains, without much anxiety of getting ripped apart in a pullback. If you do find yourself with a lot to do, in terms of activity, then odds are that you are either (1) a short-term trader (2) you are doing something wrong.
Let me elaborate on the second point since the first point is self-explanatory. If you have activity here then odds are that you are either buying into new positions heavily counting on this very bullish start to the year to continue OR you are liquidating in anticipation of the uptrend ending right around here.
You could be right in either scenario. However, either way, you are making the wrong move. I hate to pull out a cliche poker analogy, but your being correct in either one of the aforementioned moves has less to do with skill and everything to do with luck. In any case, it has a negative expected value over the long-term. Whenever the market gets you to make the wrong move, then you have made a play with a negative expected value regardless of the outcome. Over the long-term you will lose money making the same mistake, irrespective of your short-term results.
The reason why being active at these levels with either new investment buys or liquidating your portfolio has a negative expected value has everything to do with probability based on the understanding of price.
The markets (Dow, S&P and Nasdaq...even the Tranports) are all tagging significant upside resistance points at the same time. More importantly, they are doing so very early in the year, during a period when institutions are eager to put money to work indiscriminately.
Coordination in hitting or penetrating resistance points among varying important averages does have a high probability of retracement. This becomes especially true when the coordinated hit or penetration comes during the first few months of the year.
The very same individuals who are hitting the buy trigger in an eager rush to allocate assets to equities now have 11 more months in 2013 to become frightened out of those positions. Not to say that every Q1 move to the upside gets retraced. However, those that are coordinated in hitting important resistance points while in Q1 have a significant probability of seeing retracement.
That makes this general area of the market an undesirable point to allocate new funds into equities due to the significant probability of loss. So why is it an equally terrible decision to liquidate or begin liquidating a portfolio here?
Again, it has everything to do with the tendency of markets after such a move. It is rare to see a top to market that ends in spike without retesting the highs several times over the months that follow. Any potential rollover to the downside will first see several ebbs and flows along the top of the range. In the meantime, assuming you have selected a portfolio of outperforming names, good stocks will continue to create gains for investors.
The best methodology with respect to risk in current positions, at these levels, is to cut those positions that underperform over the next few months. Outperformers should be left to do what they do best, as the risk of a sudden and swift sell off in the markets during Q1 is negligible.
Let's summarize:
1. Let your profits run, if you have them.
2. Cut your losers short, if you get them.
3. Keep new positions to minimum for the foreseeable future.
If you missed out on this rally don't compound your error by chasing while the market is in a low probability profit positions. The merry go round will keep spinning. Try to do a better job of hopping on next time around.
I'll have illustrations of the coordination with which the important market averages are taking on important resistance points in the weekly review to be posted tomorrow.
