Dow Jones 12040.39 -214.60 3:28 pm PST, March 6, 2008 NASDAQ 2220.50 -52.31 For info, visit access.smallcapnetwork.com S & P 500 1304.34 -29.36 Change your subscription status here Russell 2000 662.78 -20.96 VOLUME 08 : ISSUE 22 How To Navigate A Landmine-Laden Market One of the best trading lessons I ever learned - if not the best - was to not make an assumption when there was no real basis for the assumption. In simpler terms, it just means only trade when you have a clear edge, and don't trade when the picture is fuzzy at best. I have to wonder how many of us are recently guilty of this cardinal no-no.  Today I want to look at the current environment (and charts) and discuss some of the things I think we all should and should NOT be doing while we wait for a bigger move. It'll also be the backdrop for a discussion of what may be next for stocks.    Wait For Charts To Tell You Something's Changed The fact is, the last seven weeks have basically been a wash for the market. Oh there have been plenty of ups and downs....just no net movement.  It's no big deal if you're strictly a buy-and-hold kind of person, and it's great if you're a true intra-day-trader. For the rest of us though - which I suspect is most of us - finding a prolonged 'swing' to trade has been near impossible. For the same reason I didn't get excited about mid-February's gains, I'm not sweating today's dip into the red. We've seen this happen three times now. The first two times didn't spell doom, nor did the ensuing rebound turn out to be anything more than a dead-cat bounce. In other words, we're range bound.  The challenge has been applying the patience needed to wait for true evidence of such a swing. Though all the indices offer their own version of this range-trading behavior, I think the Dow's is most clear. Support is around 12,020, while resistance is near 12,760. Anything besides a move outside of those boundaries, and I'm not interested. You can trade a little inside the range, but frankly I'm looking for bigger, faster swings. Some of the other indices are testing January's lows right now. Also, most of the other indices are dealing with a downward-sloped resistance line, which means triangles or wedges are taking shape. The principle is the same though - support is still in place, but not yet broken. My point is, should we have been fishing for a bottom or top over the course of the last six weeks? My opinion is no, we shouldn't have. Ideally, we should be responding to what the market is doing rather than assume it's going to do anything. If the market's not doing anything, perhaps we should follow that lead too. By the way, at this point I'm bearish in the near-term (a few days). The triangles I mentioned above are theoretically bearish, in that we're 'supposed to' see a continuation of January's pullback once we near the pointy end of the shape. That's a tough one for me to get my arms around, since we're also incredibly oversold right now (and sentiment is wildly bearish...more on that below). The dilemma illustrates my message ...we can't make any kind of assumptions without reasonable evidence. I'll wait for a break past support or resistance before making a major trade.   Look In Obscure Places Most stocks have been stuck in the same rut the indices have. Not all of them have been lazy though. There are some groups of stocks that have managed to keep rising or falling despite the market's general indecision. This idea looks back to something I mentioned a couple of weeks ago ...stocks of a feather tend to flock together. If you find a persistently hot or cold sector, odds are you'll find a trending stock in an otherwise non-trending market. (Note these trends can be bearish as well as bullish.)  In that February 20th edition I specifically mentioned basic materials and energy as the leading sectors, with chemicals and drilling service/equipment stocks as the leading industries within those two sectors. I don't mean to toot my own horn, but it's pretty much the way things continued.  Though clean energy has underperformed the S&P 500 since then, all the other 'strong' groups have at least staved off big losses - which is a lot more than the overall market can say. The updated comparison chart is nearby. These groups aren't leaps and bounds better, but it's only been eleven trading days. Extrapolate the difference for a few weeks, and you get a significantly better result.  In fact, for a longer-term view of the same groups, click here. It's a real eye-opener to see the difference between what could have been and what was. Even if you had focused on the strong groups for half of the performance period, you'd still have a major alpha.   Look Beyond Index Charts In some ways the final nugget of perspective may seem to be in conflict with the first one (respond to what the market is doing). It's not though...it's just an enhancement of that market analysis. As helpful as it is to watch charts, I find there's a lot of great data most people never even consider. These specifically have to do with sentiment (from a contrarian point of view), volume, and breadth and depth. Most all of you know I'm a big fan of the ISE Sentiment Index. It's a call/put ratio designed to measure how bold or scared the market's participants are on any given day. Most of the time it's in the meaningless middle ground. Sometimes though, it's through the roof or under the basement. When I see those extreme readings hit I usually start to take positions...in the other direction! Peaks in fear tend to occur at bottoms, while peaks in confidence tend to appear at market tops. Hence the 'contrarian' description.  The CBOE also has a put/call ratio that does the same thing. (By the way, check the blog on Friday. I'm going to look at the ISE sentiment tool to really explain how and why it works.)  My favorite tools, however, relate to volume. I've found breadth (the number of stocks gaining or losing) and depth (the trade volume of those gaining and losing stocks) can start to turn the corner before the market does. When breadth and depth both start to turn bearish, even if the index is going higher at the time, I can pretty much rely on a near-term correction within a few days. Flip the model around to catch the beginning of bullish recoveries. (Check the blog on Friday for an example of how I use this data as well.)  To simplify an otherwise subjective set of data like volume and breadth and depth, I prefer an accumulation-distribution line. It's not perfect, but it's quick and easy.  The Dow's accumulation-distribution line looks lethargic right now, though you can see how it's caught the early stages of breakouts and breakdowns when it broke its own support or resistance. It's been sideways since October, and isn't necessarily bearish or bullish right now. There's one more reason why I'm still in wait-and-see mode. OK, between today's edition and Sunday's edition (Bear Market Management), we've got some tools to work with just in case things get worse for stocks before getting better. We'll follow-up on these ideas as needed.  By the way, I MIGHT have a new small cap trading idea for you on Saturday. We're still doing our legwork, but may be able to formulate an opinion by then. If not, look for it sometime next week. We'll have a Saturday edition either way though.     We Value Your Feedback   Got comments, questions or suggestions? 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