Thoughts on the Market

Last Thursday's bizarre decline in the stock market--the source of which has still not been found, to my knowledge--comes in the midst of a period when the stock market has been showing increasing volatility. "Volatility" means the characteristic of a security or market to rise or fall sharply in price in a short time period. These periods usually come in bunches, so you get an up-down, see-saw effect. Volatility is usually the result of fear, or more accurately fear and greed fighting each other--between investors, or even within the mind of a single investor. These days, with so many trades generated by computer, it can be the result of programs designed to kick off massive selling or buying when certain trigger points are reached. Often (but not always), when the volatile period ends, you find that the price is lower than when it started, meaning that fear must have predominated overall.

This chart of the S&P 500 since mid-November shows what I am talking about. Notice the volatility and overall drop that took place between early January and early February. (Click on the chart to enlarge it; use the back button to come back to the article.)

Then, notice the relatively smooth climb starting on February 9 to about mid-April. Since then, it's been very volatile. On the chart, red indicates a day that the market fell, white a day that the market rose. Counting back the last 18 sessions and using "U" for up and "D" for down, we have D-U-U-D-U-U-D-D-U-U-D-U-D-D-D-D-U-D. That's volatility, folks, and during its course, the market has fallen. In fact, it crashed through its 20-day (green line) and 50-day (blue line) simple moving averages.

In my Capital Appreciation Portfolio, my 6% sell stops got taken out, of course. The portfolio is 100% cash right now.

Back in March, I wrote about what kind of pattern I look for to consider investing back into the market after going to cash. (You can see the full article here.) In summary, here are the qualifications for an "investable uptrend" in my book:

>>9% rise over two weeks, with at least 7/10 days positive
>>3% rise over 3 weeks, with at least 10/15 days positive
>>4% rise over 4 weeks, with at least 14/20 days positive
>>5% rise over 5 weeks, with at least 17/25 days positive
>>Etc.

So you can see that a highly volatile period such as we are in right now does not qualify for re-investment. Yesterday's quick snapback was followed by a small drop today. In my book, there is no current trend; if anything, it is down.

My approach does cause me to miss some upside coming out of a decline that takes out my sell-stops. It takes at least two weeks, usually three or four, before I will begin re-investing, and I will miss the gains that occur while I am waiting for those parameters to be established. But that is a risk I am willing to take in order to miss severe downslopes that, over long periods of time, tend to do more damage to a portfolio than the missed upslopes tend to help it.