Distribution finally caught up with the market as stocks fell hard on massive trade. More European debt fears emerged as Spain has asked for bailout funds giving traders a reason to dump the Euro and jump back on the US Dollar. Commodities turned lower on the move in the dollar as well as stocks. The Volatility index soared more than 25% at its peak indicating a healthy level of fear hitting the market. This fear lead to the market leaders getting hit hard on volume only a few escaped on lower volume. Price action has confirmed a correction is in place and we are focusing on protecting our capital.
If this market acts like we did in January this correction will be quick and shallow. The NASDAQ only has 4 days of distribution with the NYSE indexes leading us lower with much more distribution. Financial and energy stocks have weighed down the NYSE for quite some time putting pressure on this overall trend. It may take some time to clear out the heavy distribution on the NYSE before this market can move higher, with that said it only took a week for the market to reverse in February. It is foolish to guess if it will or not, but we’ll recognize the signs if this market can shake off this distribution.
Two likely scenarios exist with one being this market will snap back relatively quickly or we will get a longer correction. Corrections are apart of longer term runs. After the 2003 rally the market corrected 19% in 7 months in 2004 only to rally 25%. After the 1973-74 rally the market corrected 19% as well over 7 months and rallied 25%. The 1938 rally saw a correction of 24% of 6 months in duration to run 31% in 5 months. Even more impressive was after the 1929-32 rally the market corrected 39% in 6 months only to see the market rally over 122% in 4 months. As you can see, corrections are apart of bigger moves off massive bear markets. We have yet to see a correction more than 8%, 10% on the Russell 2000. Are we overdue, yes, but let’s allow the market to do its thing and take our cues from its action.
Today is a prime example as to why you must cut your laggards when the market weakens. Selling weak stocks, raising cash is a great way to protect your capital when the market is unstable like we’ve seen over the past few weeks. There are some stocks holding up and if you have a cushion plus taken profits off the table there isn’t a reason why you can’t hold onto the stock as it moves within this market. Often times leaders will quietly form another sound base and rip higher later. Right now, we are in the midst of a correction within a longer term uptrend.
Going short down here may be a bit obvious, pick your spots as we did see the market move higher near the close. We could very well just end up slicing through today’s low and continue lower. However, when a trade becomes “obvious” it usually never ends up being profitable. Stay disciplined and wait for proper setups.