After pullbacks, I prefer to get back into the market slowly when signs of strength start to appear. The main reason is to protect the downside and to protect your confidence in case the rally attempt fails. For example, last week I took light positions in 3-4 stocks to see how they would perform and so far, so good.

The key now is to observe if a few things happen:

1) The stocks that recently broke out hold their gains (watch this over the next few days).

2) Volume accumulation comes back into the market showing participation from the large institutions (so far, the past 7-day uptrend has not shown the strong volume I would like to see, but it’s still too early to make any solid conclusions).

3) If more stocks continue to build bases and “setup” technically (this could take 2-4 weeks).

My conclusion is that: so far the signs are encouraging, but you should still show patience and give the market time to prove itself. The point of taking light positions is that in case the market fails, you can get out with a small loss. If the market continues to improve, you can add to your position size or increase the number of stocks you own.

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While going over my weekend screens, I noticed that many stocks are putting in tight patterns on their Weekly charts and could be building new bases. Tightness in chart patterns is positive because it often shows a sign of institutional support. Examples include: $AMP $CHKP $HES $HANS $CL $ROST $JCI. I’m not recommending buying these stocks now because you should never buy at the bottom of a potentially new base. I would rather wait and see if these stocks prove themselves by properly building the right side of their bases. If this happens, it would give me more confidence that the market is healthy.

In addition, when looking to re-enter the market after a correction, I prefer to “test the waters” with stocks looking like they could breakout soon rather than the ones that are still building their bases. For example, if the market resumes its uptrend over the next few weeks, I suggest taking light positions in the stocks that held up well during this pullback. If they don’t work out, at least you exposed your portfolio to the best stocks the market has to offer and you can always stop yourself out with a small loss. If the stocks work out well and show you a profit, then you can add to your positions or buy the other stocks that should setup after them.

Over this past week, I took light positions in the following stocks:

1) $GMCR: Although GMCR has been a huge winner since I recommended it in March 2009, I feel this stock has more upside potential. Their earnings and sales continue to accelerate and a very sharp analyst I know said he’s expecting them to raise guidance if/when the $DDRX buyout occurs. In addition, I feel they will get added to the S&P 500 soon, they could announce new deals with other coffee vendors, and the stock’s large short interest will continue to push the stock higher.

2) $ISRG: Fundamentally, their earnings and sales continue to accelerate. Technically, the stock has held its 10-week moving average since July 2009, a sign of strong institutional support.

3) $NETL: On Feb 2nd, this telecom semiconductor company beat earnings estimates and raised guidance. Positive analyst comments about NetLogic include the company’s significant design wins, their strong organic growth, and that they should benefit from the 3G buildouts continuing in India and China. They present Thursday, Feb 18th at the Oppenheimer Semiconductor Summit.

4) $DNDN: The company’s new prostate cancer drug Provenge is up for FDA approval in May. This blockbuster drug could potentially generate annual sales of $1.2 to $2.5 billion. One note about biotech stocks, I prefer to use options 3-6 months out to limit or quantify my downside risk. For example, if you own 1,000 shares at $31 and the stock hypothetically gaps down to $5 on horrible news, you lose $26,000. If you own 10 May 31 Calls at $5 and the stock gaps down, you only lose $5,000. If you don’t understand this or don’t trade options, please don’t worry about this because there are plenty of other stocks to trade. If you want to own shares, please keep your position size small to limit potential downside.

Other stocks on my watch list include: $CAGC $IPXL $BEXP $AAPL $VECO $NFLX.

I want to reiterate: I AM NOT SAYING THIS RECENT CORRECTION IS OVER! I am simply saying that some constructive signs are allowing me to shift my stance from a cautious mode to a neutral one. I suggest keeping a watch list of strong stocks that have held up well during this correction and being ready to pounce if the uptrend resumes in the next few weeks.

Please keep in mind that the purpose of this blog is to help people with idea generation. If you trade some of these stocks, PLEASE, PLEASE, PLEASE use stops. In other words, if some of these stocks turn against you and the market doesn’t cooperate…protect your portfolio! Thank you. Good luck trading!

I will be at the TradersEXPO in New York City this week from Feb 14-17th. Please send me a message if you plan to be there. I’m always happy to connect with and meet new traders.

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Although I feel there may be more downside to this correction, I am keeping a close eye on the stocks that are holding up well. I actually don’t mind when the market corrects because that’s when the strong stocks stand out. For example, over the past two “down” weeks, I’ve been paying special attention to the stocks holding “up” well with the theory that when the market is done correcting, these stocks should continue higher. In other words, the recent correction is acting like a “spring” compressing these stocks down. Once the market relieves this tension, these stocks could breakout to new highs.

This is one of my favorite ways to use Relative Strength. You can read more in my blog post from last October titled: The Three Ways I Use Relative Strength.

Here is a current watch list of stocks holding up well: $GMCR $DNDN $CLNE $EVVV $ISRG $BEXP $SWM $ASH $PRX $RUE $MAPP $PAY $IMAX $PNRA.

I am not saying to go out and buy these stocks right now. I am simply encouraging you to keep an open mind and to maintain a watch list of stocks that are holding up well during this correction. Again, I still feel there could be more downside, but be ready to pounce on strong ideas as soon as the selling pressure is finished.

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