When Will the Rally Fail? (Managing the Trade, Part III)

This note went out at 11:20pm to subscribers of RR&A.
This is not investment advice, and has been posted in
chronological order of when it was emailed as a courtesy to blog
readers.

For more information, see the disclaimers at RR&A.

Our first follow up to the June 13 trading call advised raising your stop loss to break even; The next email alert advised moving your stops up to protect half your profits.

The reasons for this became clear in today’s selloff. The action took us out of our QQQQ position. Assuming you followed the discipline, you were likely stopped out with a modest profit on the Qs. On the other hand, the Dow Diamonds (DIA) are still substantially above our buy points. (S&P is also above its halfway point — but just barely).

This is rather telling. When the Nasdaq underperforms the Dow, it typically reflects that investors have been chastened and are starting to show some nervousness. When the crowd clings to biggest, blue chips — the "safe" names — it is out of fear. And, it can mean that more selling may be near at hand.

This raises a concern that this bounce off of the June 13 lows was just
that: a dead cat bounce. We are always on the watch for signs that an oversold rally may not last the 3 – 6 weeks that is typical. Today’s action raises that possibility. We will continue to monitor the situation, and advise you how to proceed.

For now, we will be keeping our long DIA position open, but sticking closely to our stop loss discipline at 50% of the recent gains. As soon as any of our stop loss levels are violated, we sell the stock and close out that position. Missed opportunities can be made up much more easily than lost capital.

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Separately, look for a longer market commentary later this week.

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And in response to several requests, we have posted three "classic"
investing commentaries
. These are not market calls, but are instead general "how to" investing advice:

"Contrary Indicators 2000 – 2003 Market" is a technical review of the signals that suggested the first phase of the Bear Market was ending; It makes for an interesting contrast with the present conditions;

"The Cult of the Bear" explains all the cyclical, technical and economic reasons we are concerned about a market selloff this year;

"The Zen of Trading" — is a 10 point overview of our approach to investing;

These pieces are "weekend reading" and can be looked over at your leisure.
We hope you find them helpful and informative

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What's been said:

Discussions found on the web:
  1. Rahul Jain commented on Jul 5

    It’s not a fear of more speculative names, as the Russell 2000 is holding up quite well, relatively. It’s the “tech” stocks that people are fearing. Currently I’m quite bullish on small cap value, but keeping a good position in mid cap value as well as large caps (focusing, again, on value stocks).

    I have noticed an interesting negative divergence, however. The cumulative advance-decline is showing a waning of momentum in a longer-term view. Looking back to July 03 of this chart, we see 4 major cycles, each of which is accompanied by a lower high in 30-day RSI (of the cumulative A/D itself).

    http://stockcharts.com/h-sc/ui?s=$NYAD&p=D&yr=3&mn=0&dy=0&id=p78553408940

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