Why You Might Want to Take a Breather

“Calling the Trend” Column, by George Leong, B.Comm.

Markets saw a bounce on Tuesday, but, make no mistake about it; the current market risk remains high. I am still concerned about the jobs and housing markets and their impact on consumer confidence and, ultimately, GDP.

Market guru Gary Shilling, in an interview on “Tech Trader” said he feels that there is a 40% to 50% chance markets could retest and fall below the March 2009 lows. Just like us, Shilling believes that jobs and consumer spending will be problematic. Much of the rally in 2009 was driven by optimism towards growth in 2010 and 2011, which remains a sore spot for many pundits.

With U.S. and global markets continuing to be under pressure, it may be time to take a breather rather than jumping in and risking your capital. The market breadth and Relative Strength are extremely weak, as there is little interest in buying at this time, with the exception of some oversold buying support.

So, as an investor, what are your options at this time?

The most important thing in my view is prudence. I highly advise against chasing stocks higher on a rally, as the latter likely won’t be sustainable in the current market environment, as we have seen. But, if you want to trade this market by buying on dips and selling on rebounds, you will need to make sure you have stops in place just in case the support levels fail. This type of trading a sideways trading market could reap some nice gains. Pick only a few stocks. Become familiar with their trading pattern, and off you go.

You can also stay on the sidelines and wait for things to settle down. The intraday volatility is intense and is not advised for the majority of investors. Keep cash in high-interest-paying accounts for easy access in case we see further correction in stocks to more attractive levels like in March 2009.

If you own some large blue-chips, you may want to take the opportunity to accumulate shares and dollar-cost average on market dips. Your portfolio should always have some blue-chip “best of breed” stocks.

For those of you familiar with options, another alternative would be the use of put options for a single stock or a basket of stocks in which buying put options to match each stock would be both economically infeasible, as well as improbable due to the limited selection of put options. If you own a basket of stocks, look for a stock index option that has a high statistical correlation with your particular group of stocks. For example, for a tech-weighted portfolio, take a look at puts on the NASDAQ or NASDAQ tech index. For blue-chip portfolios or those with a small-cap focus, you should check out puts on the DOW and Russell 2000.

Yet, at the end of the day, the bottom line is to be careful and watch your positions carefully. Be careful that stops are not too close or you risk being stopped out prematurely during times of volatility. Always take some profits on the big gainers.