Trend Lines Violated – Time to Buy or Sell?

Well, I guess we are all feeling a little bit better after Tuesday’s nice recovery.

On Monday I thinned out my portfolio to bring the cash component up to around 10%. In hindsight, I guess I should have left it as it was, but better safe than sorry. Fortunately I didn’t panic and sell everything. Now the real question: was today the end of the correction and the start of the next bull run, or was today the exception, and hence the consolidation will continue?

I have no idea. If I was psychic, I wouldn’t be writing this blog; I’d be out buying the winning tickets for this week’s lottery.

My guess is that, as always, the market over corrects. It goes up too high, and then over-corrects, like the car driver swerving to miss a dead squirrel on the road, and turning so much he loses control and plows into a hydro pole. (The squirrel is already dead, that’s why it’s lying all squished on the road; drive over it; don’t risk your life to avoid it). I therefore believe the correction was over-done, and we should be back to nice gains from here.

Of course, now that I have admitted I don’t have psychic powers, it is equally possible that I’m wrong, and the correction will continue.

So what to do?

Simple. I will do nothing until the trend becomes more apparent. In other words, I will let the market tell me what to do.

If we have a down day on Wednesday, I’m not going to panic. My portfolio was up almost 9% today, so a pullback on Wednesday would not be surprising. If my portfolio pulls back more than 9% over the next two or three days, then obviously Tuesday was a blip, and it’s more bad news ahead. If, however, the lows established on Monday hold, the uptrend will have resumed, and I will consider deploying more cash.

My approach has always been to buy high sell higher, which means to buy as stocks are rising, with “rising” being defined as “the trend lines are going up”. However, with the steep declines of the past week, most of the up trend lines have been violated, leading Swindle to ask the following question on the Buy High Sell Higher Forum:

I know that “the trend is your friend”, but how do we compensate for the recent wonkiness of the market when planning our strategy? According to all of the new charts for this week, we should sell everything. On the average, the uptrend lines have all been violated. Assuming that everything will get better, is there a way to compensate for the severe dip, or do we just start over and build new uptrend lines from here? 

Good question. Should we sell everything because the trend lines have been violated? Here’s a good example: the chart of JNN.V – JNR Resources Inc.

As you can see, the uptrend line going back to last October was violated. However, as you can also see, Tuesday’s recovery has brought the price back up above the trend line. What does this mean?

It could mean, as Swindle suggests, that we draw new uptrend lines using Monday’s low as the base. The other option is to assume that this past week was an anomaly, and the trend from October remains unaffected. I tend to believe the later, until I see I few more down days to convince me that I’m wrong. (When I’m driving down the street and I swerve to miss the dead squirrel, I then correct and resume my course on the same road; I don’t start driving on a different street, unless there are dozens of dead squirrels that make the road impassible).

Therefore, I plan to stay the course; I think by the end of this week the trend will be more clear, and I can resume buying (or accelerate selling) starting later this week or early next week. In a perfect world, the correction we were expecting in the spring may have already happened, and perhaps we will have a good run from here. Time will tell.

(LEGAL DISCLAIMER: No squirrels were harmed in the writing of this blog).