Are We Really Overbought?

Market is poised to pullback as the consensus or sentiment becomes an overbought market. I am still amazed at how the short term direction is dictated by theories of overbought or oversold. Get enough investors to buy into the idea and before you know it the masses follow. We see this same theory taking place currently with healthcare. Get enough people to believe the system is broken and you rally change. The current attempt to restructure our healthcare system is a result of rising costs and some percentage of citizens (not illegal aliens) who don't have health insurance. Instead of fixing or adjusting what will fix the current challenges, we are going to change the entire system with no idea of cost or ramifications. The following was faxed to me and I wanted to share it with you as food for thought on the complacency in our current system by the ‘many', while the ‘few' make changes.

Chuck was a young cowboy in Texas and he bought a horse from a farmer for $100. The farmer agreed to deliver the horse to him the next day. The farmer drove to his house and said, "Sorry Chuck, but I have some bad news, the horse died!"

Chuck replied, "Well give me my money back."

The farmer said, "Can't do that, I went and spent the money already."

Chuck said, "Ok, then, just bring me the dead horse."

The farmer asked, "What ya gonna do with a dead horse?"

Chuck said, "I'm going to raffle him off."

The farmer said, "You can't raffle of a dead horse!"

Chuck said, "Sure I can, watch me. I just won't tell anyone he's dead."

A month later, the farmer ran into Chuck and asked, "What happened with the dead horse?"

Chuck said, "I raffled him off. I sold 500 tickets and made a profit of $998."

The farmer asked, "Didn't anyone complain?"

Chuck said, "Just the guy who won. So, I gave his two dollars back."

Chuck grew up and became the Treasury Secretary, he's designed the current "bail-out" program for the financial sector.

(the names were changed to protect the guilty.)

I found this amusing, but unfortunately it is too close to the truth. Listen to what you hear and determine if it true or just the tail wagging the dog!

The chart below is the S&P 500 index. We have discussed the potential resistance near the 1005 mark and we are still struggling somewhat at this level currently. The move last week to 1010 has come under pressure this week as investors begin to question the move higher. The outlook remains a gradually improving economy and growth in earnings and revenue for companies. The ‘few' have started a media blitz to question the validity of the current move relative to earnings and growth. The discussions have focused on solid facts of the indices moving up as much as 50% off the March low and need to take a break or consolidate. They show charts and discuss in eloquent terms why we are overbought and due for a correction or pullback. I find myself in the camp of believing the market is ahead of itself. However, these same prophets are the ones who never saw the market falling 40% from the 2007 high.

Looking at the chart we see resistance at the 1005 mark currently. Thus, to answer the pundits and my concern, the logical solution is to set a stop at the level of risk I am willing to accept currently versus pontificating on what and why I think relative to the market. Yesterday, I posted a piece on KISS (Keep it so simple - you can do it!) and today I want to keep it simple. The support based on the chart is potentially the 20 day moving average at 978 or 950 the previous resistance. If those are broken you can see the logical progression of support on the downside. Why am I posting these? The number one question I am being asked currently is if I think the market is going to move lower or continue the uptrend. To be one of the few who will admit the fact, that I don't know, leads to money management. I own the S&P 500 index (IVV) and I want to protect my gains. Thus, no one knows where the market is going, I must then manage money not prophecy what I think will happen.

Money management at this point begs the question - how much risk am I willing to accept at this point? 978? 950? 875? Each have a degree of risk and probability of happening. If I am up 15% at this point how much of that gain am I willing to risk relative to what I believe? That is the question we each have to answer at this point. The answer is not - "you are in this for the long term, so don't worry about what happens short term." Those are the investors who gave up 40% of their net worth in 2008. How much risk are you will to accept at this point in time relative to the current market environment? If we say 950 we are willing to risk 5% of the position. If that is acceptable set your stop accordingly and see how this plays out. Yes, this is simple. More importantly it is so simple you can do it! In the process you are managing your money and your peace of mind going forward.

Don't be the one holding the winning ticket only to get your $2 back because the horse is dead! Keep it simple and manage your money!