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Caution Warranted As Volatility Rises

I use a few signs to let me know the market is not conducive to trading aggressively and that caution is to be warranted. These include sentiment readings, the action of major market indexes, seasonality, and the behavior of leading stocks. Let's take a look at where we stand currently.


Sentiment

Bullishness has gotten off the charts the last few months. Everyone seems to be in the market now and stocks like AMC and GameStop have gone on ridiculous moves. Periods of extensive bullishness cannot last forever and often signal market turning points. The NAAIM survey of investment managers shows an extremely high level of bullishness. These types of readings are rare and signal that the market is getting overheated.



Market Indexes

The general market indexes are also extremely extended from their major moving averages. Take a look at the Nasdaq. It has gotten quite far from its' 50-day and 200-day moving averages. Some time to digest the monster gains from 2020 would be normal and expected given the fantastic trend we saw over the past three months.


Seasonality

The months of November to January are by far usually the best three months of the year to be in the stock market. With those months behind us and earning season upon us, market volatility can be expected to heighten once again.


Behavior of Leading Stocks

This is by far the most important stock market indicator and it supersedes all other indicators in my opinion. If I see a leading stock setting up, I take the trade even if the market is extended or if sentiment is excessively bullish. However, when I find myself being stopped out of many of my trades, that is an extremely bearish sign. While stocks like BLNK, PLTR, TDOC, and JMIA have seen some nice moves, I have been stopped out of other trades such as APPS and DOCU that normally work in a healthy environment.


My philosophy is to do more of what is working. If I'm trading really well, I look to add more to my winners or to add more positions. If stocks are reversing or if I'm getting stopped out, I look to scale back. I still hold my best stocks like TDOC, but am certainty not going to add more positions if volatility starts to rise and the market is telling me caution is warranted. When you see difficult conditions which the market seems to currently be indicating, it is best to step aside. Market corrections can be really helpful because they provide an opportunity to analyze your past trades and to study the previous' years biggest winners. They also provide the market the chance to build new set ups that will lead to future market leaders.



Full Disclosure: JMIA and TDOC are stocks I currently own.

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