Following the Rules

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Plenty of charts that I am looking at this evening are quite sloppy. Even the ones holding up well, such as the daily charts of both the IYR (real estate ETF) and Dow Jones Industrial Average, have merely wedged higher in textbook bear flag fashion. Now, those bear flags are becoming quite obvious and, especially in light of the fact that we are in an overall bull run (rising 200 day moving average on the indices), they should be viewed with a critical eye as potential traps to lure in eager bears. The bear flags could also easily morph into broad technical bases. If that happens, though, it would be a tedious process and not worth the risk of diving in head-first long right here, right now. This type of a market places a premium on traders following a disciplined set of rules. Otherwise, capital losses can pile up quickly, in addition to swift erosions of confidence.

Thus, I would characterize the risk/reward profile here as being high risk of further downside versus moderate upside reward. The S&P 500 has already corrected 4.5% from its recent highs. If many charts were starting to firm up, I would be inclined to look to layer into longs here. However, because the sacred cows in the form of momentum leaders like AAPL CMG PCLN SBUX became safe havens for hot money traders, my sense is that their finally cracking today might presage a bit deeper of a pullback than the standard 3-5%–Perhaps something along the lines of a 6-8% correction.

The other scenario that I keep revisiting is the rotation theme. We saw glimpses of it today, with the XLB (materials ETF) and XLF (financials) turning in green sessions. However, the power of some of the aforementioned momentum trades unwinding a bit here should not be underestimated. In other words, I will wait for a better spot to seek a confrontation with the market.