Don’t Sweat a Pullback. Profit from It…

Over the past couple of weeks, bullish sentiment has continued to grow to a fever pitch. Naturally, overwhelmingly bullish sentiment can be an effective contrarian indicator signaling that a pullback is eminent.

Bearish technicians are ready to pounce on any sign of market weakness. However, we believe the bulls have little to worry about, even if we do experience a broad pullback in the markets at large. Here’s why:

• A pullback does not confirm the end of a bull market rally. You have to tune out the short-term prognosticators and day traders because, frankly, their time horizons are so different from that of an investor that it does us no good to worry about how they are reacting to the market. It’s not until a correction begins to breach major support that we will have any cause for concern. If small-cap market leaders continue to perform and hold their gains, chances are that a pullback is just that — and a not a change to a bear market.

• A break in the action can be healthy for the overall long-term trend. There’s an old trading strategy out there that goes something like this: You should buy with the longer-term trend, but against the short-term trend. It’s a fancy way of saying “Buy on the dips.” Buying the dips would have served you well in 2010 — just look back at the sharp market pullbacks in January and July/August. Investors took advantage of these prices, bought the dips and sent the market to new highs by year-end

• Everyone is anticipating a bear move, instead of reacting to the market. While they should be reacting to market moves, many talking heads and prognosticators try to guess where the market is heading in the short term. As a result, shorts will jump in early, making big bets on some of the best-performing stocks on the market — the ones they think are overextended. It’s a risky strategy that can actually cause the market to move higher in the short term, should longs squeeze their positions.

The most important take-away here is to know what style of trading/investing works for you, and use this particular timeframe to your advantage by acting as a shorter-term contrarian. Any pullback will give you an opportunity to evaluate your open positions, find new potential trades and locate where the real, sustainable strength is in the market. Then, when market leaders begin to move again, you’ll be prepared to take full advantage of the next run.

Sincerely,
Greg Guenthner
Penny Sleuth

January 18, 2011

Don’t Sweat a Pullback. Profit from It… was originally featured in the Penny Sleuth. Check out Wall Street’s 5 Most Profitable Penny Stock Patterns Report.

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