Friday, August 21, 2009

Avoiding The Whipsaw

The Tuesday edition of Investor's Business Daily called the Market In Correction based on the accumulation of distribution days and Monday's sharp decline. I don't know what they will say in this Monday's edition, but it sure looks like today was a follow-through day to me. That said, how could traders have avoided the potential whipsaw this change in market stance created?

The simplest way is to add two simple confirmation criteria to IBD's market calls: 1) look for confirmation from the MACD, wait for the MACD to turn positive on the SP500 or Wilshire 5000 before going long after Market In Confirmed Uptrend calls (reverse for shorts); and 2) wait for the market to move at least 1% in the direction of IBDs market call the day of the call or on a subsequent day when the MACD is in agreement. In this case, the market did not confirm the call by selling off at least 1% on Tuesday, while the MACD was on a sell signal. Therefore traders could have maintained long positions without getting whipsawed.

So what about the current follow-through day? Since the Market In Correction call was not confirmed, traders need not wait for additional confirmation to go long.

However, I continue to expect some volatility in the next week, so caution is advised. We are most likely heading into the last leg up of this initial rally off of the March lows and some stocks will begin to break down early. Breakouts may fail. For those who wish to increase long exposure, the time to do it will be before September 8, in my opinion, as risk could increase significantly after that date.

This is also the time to begin screening for potential future short positions, as the weak stocks begin to break down before the leaders.

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