The line in the sand...

by Adam Beaty

With every new extreme declining day it always seems to flush out the traders calling for the next market top.  We've come to notice that there are a lot of traders in the business of calling tops even if they must repeat for weeks or months until they are right.  What we tend to tell traders is to stick to what the charts tell you.  There is a lot less panic and uncertainty when you listen to what the charts have to say.

How can one easily tell if a market or stock is in an upward or downward trend?  Well if the market is in an uptrend we will see a series of higher-highs and higher-lows.  If the market is in a downtrend we will see a series of lower-highs and lower-lows.  These are pretty easy to see and map out.

Let's take a look at the mother of all charts, the S&P 500..

Here is the SPX chart showing the low from March 16, 2011 till the close of today (May 11, 2011).  Obviously I have marked out the higher-highs and higher-lows which shows the uptrend the market is currently in.  If we take today into account we can see that we have not made a higher-high and looks like we could find ourselves not making one at all, or maybe we bounce and head past 1370.  Who knows which way this market will pick, we sure don't.  We could decide to call for a top here but why not just wait for the market to tell us what to do.  Our lines in the sand are 1370 to make a new higher-high or 1329 to turn this into a down trending market.  That is pretty simple and basic analysis that is easy to forget when a thousand indicators, Fibonacci lines, and trendlines are flowing across your chart. 

So how about trading these defined trends.  Normally one would want to ease up on the long positions and start taking on some shorts when the market creates a new higher high.  And the opposite is true looking at a new higher-low.  Now we are caught in a bit of uncertainty were the risk/reward is not ideal.  The best idea is to keep swing positions light right now.    If the market pulls back to 1329 it could be time to try out a couple of long positions.  However, if the market cannot hold at 1329 it would be time to move to the short side.  Pivoting around the 1329 mark would set you up for a solid risk/reward in your trades.  Best idea is to keep the watchlist growing so you are ready for anything the market throws our way.

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