Back on July 22, 2011, I was long 6 stocks. A sharp trader friend of mine looked at the 6 charts and said: “Those are REALLY good setups, if they fail, the market is screwed.” Two trading days later, I got stopped out of the 6 stocks and went into 100% cash (I wrote a blog post about it on 7/26/11). In the following 10 trading days, the Dow dropped nearly 2,000 points due to the debt ceiling crisis.
After this happened, a lot of people asked me: “What did you see? How did you know?” The answer is: I didn’t know. I just got stopped out of some decent setups and there was nothing left to buy that fit my investment criteria. I had no idea the market was going to drop, I simply went by what the price action was telling me.
Fast forward to today’s market. I’ve been saying over and over and over: “Pay Attention to Price Action.” I get a lot of emails asking me specifically what I mean, and here are a few answers:
1) I mainly trade Russell 2000 stocks. Not only is the Russell 2000 ($IWM) acting well, but the S&P 400 Mid-Cap index ($MDY) is also near ALL-TIME highs.
2) I am noticing weakness in consumer staples ($XLP), which is normally a defensive sector.
3) I am noticing strength in Emerging Markets ($EEM), which is certainly not a conservative trade.
4) The past few days I’ve seen tons of Bullish Engulfing patterns, which is a great sign from a technical point of view.
5) There is little distribution (professional selling) in the Nasdaq Composite.
6) One side note which has more to do with sentiment than price action: Last week, I noticed more people shorting $AAPL, buying puts, and talking about a break below $500. It’s not a scientific indicator, but simply a casual observation that I haven’t seen THAT MUCH bearish sentiment in $AAPL in a long time. That is a decent sign from a contrarian point of view.
I’m not saying I’m a raging bull. I realize the market still has a lot to prove and will continue to be choppy. However, I came into this week with the most number of longs I have held in a while. There’s a lesson to be learned here. I didn’t do it because I “knew anything.” I did it because the price action of individual stocks guided me that way. If you pay attention more to the price action and less to the news, you’ll be surprised how well stocks can lead you both in and out of the market. Good luck trading!