Monday, February 03, 2014

Cash is a position

As the charts below show, the major indices are currently moving downwards and gave short signals about ten days ago.

People often talk about entering positions on pullbacks as being safer, or lower risk, compared to entering on new highs. The question then to ask is: what constitutes a pullback? How do you differentiate between a pullback, a correction, or a market downtrend? One man's retracement is another man's trend reversal.

Using a systematic approach such as a trend following system helps you avoid such having to answer such questions. you simply follow what your system is telling you - opinions don't count, but price action does.

Individual traders can afford to stay on the sidelines and sit out these downtrends should they wish. You don't have to be invested in the market all of the time. This is an important positional advantage. Those who have the ability to go short stocks or indices can make money in times such as these. However, it is important to remember that, in general, markets can fall a lot quicker than they go up, and rallies within market downtrends can be short and violent.

Also, markets like these can also show how they can stay 'oversold' for much longer than people anticipate. Hence, trend followers pay little attention to indicators used to identify overbought or oversold markets- price is all that matters to them, and if it is moving downwards, then that is the direction they are looking to trade. There will be no trying to pick the bottom of the market.

Of course, there will be stocks that are still acting well within the context of an uptrend, and are exhibiting a high degree of relative strength compared to the general market. But remember that trading is an odds game. If the general market is going down, then chances are the vast majority of the market constituents are also going down.

If you do not feel comfortable shorting this market, then revert to cash, and stay on the sidelines until you get a signal to re-enter the market. Do not try and predict where the bottom of this downtrend is.

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