What’s Going on with the Profit-taking?

stock market analysisI continue to be on the bullish side, but at the same time I am concerned with the mounting debt and deficit issues in the U.S. and debt issues overseas in Europe. In Ireland, investors are dumping Irish bonds on mounting speculation that the country will need to ask the European Union for bailout help similar to what Greece had to endure. Given this, interest rates on the 10-year bond in Ireland are at a new high since the start of the euro 11 years ago, and this is not good for a country in crisis. The situation is worrisome, as there is speculation that Spain and Portugal could soon join those countries requiring emergency funds. I expect the upcoming G-20 meetings will allow the world’s top countries to try to remedy the situation and avoid a relapse in Europe, along with avoiding a currency war.

Stock markets are pausing on profit-taking after the stellar rally. The positive has been the lighter trading volume, which means we are not seeing a mass exodus to sell. Yet, unless we see a fresh buying catalyst, stocks could be heading lower and could correct. Again, I’m not sure a correction is in the works, but clearly there is ample froth in the current stock markets.

Be careful, as the CBOE Market Volatility Index (VIX) is trading at 19, a sign of relaxation amongst traders, yet markets do not run up in a straight line without adjustments along the way. The relaxed nature of traders may foreshadow a pending downside move should the sentiment turn down.

Take a look at the market momentum, which has been declining over the last few sessions. The new highs on the NYSE were significantly lower, with 398 new highs on Tuesday and 360 new highs on Monday, compared to 603 new highs on November 5 and a whopping 679 on November 4. In bull markets, the number of new highs tends to rise. You need to monitor this as a potential indication that traders may be jumping off the buying bandwagon.

I view the current profit-taking as a normal and healthy adjustment during a bullish uptrend, especially given that the technical condition is extremely overbought. The rally has been surprisingly sustainable, but I have wondered about how easy it was for stocks to move higher, so continue to be careful here and take some profits.

The reality is that you need to be prudent and take some profits on some of your big winners. Also, you should adopt some hedging strategies, such as buying Put options on stocks and indices.

I believe in utilizing strong risk management to protect your investments and hard-earned capital. While the stock markets are in a bull phase, you still need to be careful.