Morning Market Thoughts
Good morning. The futures are dipping a bit this morning, which isn’t really much of a surprise. Last night we were discussing the “3 Day Rule of Thumb” in the Strategy Session. Market breadth has been narrowing for quite some time. By itself, declining market breadth isn’t the biggest deal. Yes, it’s a yellow flag because of what it indicates — fewer stocks are moving higher, and more stocks are moving lower. So money is starting to concentrate in an ever-shrinking number of stocks, while the stocks that are being discarded are sinking.This is best seen by the advance/decline line. The A/D line printed its first lower high on August 1st. While the major indexes were still relatively flat, and the Dow-30 went on to print a new all-time high on August 8th, the number of stocks still under accumulation was noticeably on the decline. Again, this is definitely something to monitor. But as long as you are in the strong stocks, you’re fine. I discuss this on occasion — when there are fewer stocks to choose, then it’s actually a bit easier to choose the right one. If Baskin-Robbins expanded its list of ice creams to 310 flavors, I’ve gotta think that going into that store would be a bit stressful. Soooo many choices. How do you know which one is best? They give you a little sample of anything you’re interested in. So if you start sampling everything, you consume 2,500 calories before you even make a decision. (Kind of like racking up thousands of dollars in commissions before you are able to find the stock that you can just stick with).
So when the list of choices is small, it’s a bit easier to be where you want to be. And it’s also a bit easier to know when it’s time to go.
Be aware of the health of the semiconductor ETF ($SMH), the technology ETF ($XLK), the financial ETF ($XLF), the consumer staples ETF ($XLP), the metals/mining ETF ($XME), the Retail ETF ($XRT) and…sigh…the energy ETF ($XLE). You’ll see that retail and energy continue to search for the basement, while metals seem to be stabilizing and just might be ready to move higher. SMH and XLK are looking surprisingly strong after a couple of shots across the bow during these past couple of months. The financial sector (XLF, $DJUSBK) is also in a holding pattern — where it’s been since March.
So, looking at the big picture, there is nothing truly amiss in the market. Breadth is declining, but aside from energy, nothing is really cratering. Lots of yellow flags, but no big red ones.
I’ll discuss this in today’s training session at noon ET (9 am PT), along with many of our stocks that are still working. We’ll also discuss the importance of understanding risk. If I had to pick one mistake in trading that is always fatal, it’s not picking the wrong stocks. It’s not trading too much. It’s not even failure to use stops. The one mistake that will ultimately end your trading activity and lead you to the inescapable conclusion that “the market is rigged, and no one can make money” is the failure to appreciate risk. Even if your probability of profit on a trade is very high, it’s never 100%. So if you are trading with very large position sizes relative to your portfolio size, you’ll ultimately meet disaster because, at some point, the probabilities will go against you. That 1-in-10 chance that the trade will go against you will ultimately bite you. The 10% chance of disaster will wipe you out…when that 10% reveals itself in your latest big trade.
By managing risk and building the worst case scenario into your trading actions, you keep yourself in the game, even during those times when the game is going against you. If you learn nothing else, this is the most important element of trading in your skill set.
See you in the forum, and at the training session at noon.
–DAN
Market Update