Defense Wins Championships

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The bulls are giving it a go here, as we are well off this morning’s lows. However, the market is still clearly down and is currently coming to terms with the Egypt lows from late January, of around 1275 on the S&P 500. While you may be hearing the sounds of heavily long traders breathing a sigh of relief right now because we did not crash, you should have been playing great defense over the past few sessions. Although the situation in Japan in a very fluid one, and no one could have predicted the initial earthquake (except Dennis Gartman), simply put the sloppy and weakening price action over the past few weeks should have put you in mostly cash, from a swing trading perspective.

There is a time and a place for everything, but going full pedal to the medal all of the time as a trader is long-term money losing strategy. As much as you might love to trade and feel compelled to perpetually “give action,” you might take a different approach and acknowledge your love for trading so much that you do the things necessary to see to your survival in this business, rather than placing yourself on the edge of the cliff too often to sustain your trading account.

The good news from these recent sell-offs is that Mr. Market is cleansing the arrogant, complacent, and patronizing tone of recent dip-buyers about how you need to be in this game at all times in order to win. The reality is that playing great defense in your portfolio is what will ultimately keep you in the game, so that down the road you can eventually go on the offensive when you find a better spot. Anyone who claims that making money in any form of gambling is simple and easy is selling you a bill of goods of which you should never take delivery.

(Direct Link Click Here)

[youtube:http://www.youtube.com/watch?v=JghkG4WydNk 550 412] ___________

TAN, the ETF for solars, is ripping higher today and confirming the possible bullish reversal mentioned over the weekend. I discussed the possibility of a Morning Star Doji bullish reversal in the making, but what we have seen today is actually the Abandoned Baby bullish reversal pattern.

What is the difference between the two? The key point is that in the Abandoned Baby there is no overlap between the doji and the candles of the other two days. Hence, the doji, or baby, is truly “abandoned.”

Abandoned Baby patterns are rare and should be respected. Even if you do not want to chase solars up today, it would behoove you to keep them on your watchlists.

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The market has given back all of its gains from last Friday’s bounce, and as I am writing this I see we lost that key 1294 area that dates back to at least 02/24. Breadth is pretty soundly negative, despite some good action in many of the solars, a group that I profiled over the weekend as potentially being the first sector to bottom. Other than that, it is awfully tough to put on swings for longer than a day or two at most, particularly when we see the Russell 2000 small cap index struggling with its 50 day moving average as newfound resistance.

The bottom line is that the price action we are seeing is that which is most closely associated with a correction. It is no reason to panic, but it does merit strong caution and an increased focus on protecting capital for the time being. Another issue I see with this market is that we simply had too many bulls, even after last Thursday’s bloodbath, who complacently and arrogantly argued that just buying low and selling high was the key to getting rich. The reality is that before this correction is over, a fair amount of those bulls will be punished and even converted into bears.

Rather than hunkering in and taking the pain of a correction, the better approach is to step aside and make a cogent list of names holding up well, showing relative strength. It is also constructive to watch for sectors that become too extended to the downside and are showing bonafide signs of bottoming.

I see there is a report out that “Anonymous,” a hacker group affiliated with WIkiLeaks, plans to release a slew of emails obtained from inside Bank of America. While I am happy to see that Julian Assange and his fellow wannabe cool kids have moved on from Dungeons & Dragons to the real world, I have to wonder how scandalous it is to presumably find out that a bunch of scumbags and shady cats work on Wall Street.

Rather than get caught up in “trading the news,” which I see is the chic thing to do these days, I will stay within the context of my philosophy and analyze the overall price action.

Looking at a daily chart of BAC, zoomed out, we have a serious attempt at a major bearish to bullish reversal (dating back to the correction that began in April, 2010). Over the past two months, after a sharp rally since December, the chart has settled into a textbook symmetrical triangle, with higher lows, but lower highs (pink lines). Note that this pattern can also be interpreted as a bull flag, or bullish continuation pattern of the rally from December. Note also the longer-term moving averages starting to smooth out, not to mention the 50 day turning up.

Either way, unless we see a high volume selling affair over the next few days that completely obliterates this setup, I would be looking for serious support buys in most of the major financials, including BAC.

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After starting out 2011 in style, the solars fizzled out in mid-February, even as tensions in the Middle East saw crude soar. While many other areas of the market have just recently gotten hit, solars have clearly been in multi-week downtrends. The idea now is to gauge whether they will now be the first ones to emerge from a broad market correction.

While many traders are declaring broad market bottoms after a variety of bullish engulfing candles printed on Friday, I would caution that bullish reversal candles are most valid only after established prior downtrends. As an example, “hammer” candlesticks are printed all the time on charts, and too often traders make poor decisions by simply declaring that any old hammer is bullish and aggressively buying a stock based on that thesis. In reality, hammers are really only valid bullish reversal signals after a steep prior downtrend, and with upside confirmation (not to mention, they are usually bearish omens after an established uptrend, called “hanging man” candlesticks instead).

Hence, I would be much more apt to look for a tradeable bottom in solars, than I would in the broad market and other areas. At the top of this post, compare the daily charts of TAN, the ETF for solars, versus the daily chart for the QQQQ ETF. Can you see the difference? Solars have clearly been in a steep downtrend, while the Q’s have come in off the highs to be sure, but are hardly at the tail end of a multi-week decline.

Below, you will find several annotated daily charts of some solar names that I will be watching closely early next week.

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