The Trend is Your Friend - Until it Isn't

The market continued to roll higher yesterday, steamrolling all shorts out of the way. Many technical indicators point to further upside and the age old mantra of the trend is your friend is at the forefront of most traders minds. The problem with this is that until the economy is on solid footing there is a very high probability that all of this ends poorly, hence the trend is your friend until it isn't.

Nobody knows for sure when that will be and certainly we have had our share of excessively volatile days, but ignoring the fact that the market is rolling higher and sticking to your guns as a short is cause for not only angst but also large losses. The problem is that no sooner have you taken your protection off than the market has a large draw down. So what to do?

Certainly at this point it is difficult to continue to add to your long positions. The problem is that there are so many people out there waiting for a pullback to buy that it never comes, but adding here is a dangerous proposition. Hopefully you had a decent long position going into the rally and you are slowly leaking some stock into the run taking profits as they are handed to you. Stay disciplined and take the position off if your target is met.

Trail all positions with a stop. Certainly any positions that have been implemented due to the market momentum should always have a stop, but at this point I would also think it prudent to put in stops on certain volatile issues that you own.

Finally look for deep out of the money put options. These can be purchased cheaply and form a good deal of protection and potential upside if and when any large market draw down occurs. One thing I have learned over the years is that when markets turn they are fierce, quick and lethal and these options should reward you well at that point in time. Up until then they will all slowly die worthless so you need to be vigilant and constantly top up your holdings.

Remember that we are still well below the market highs and therefore are still in a secular bear market. Furthermore the rallies in the market are being driven by an ever weaker dollar. This is not a good environment for stocks as at some point the orderly downward spiral of the dollar could turn nasty at which point stocks will be hammered along with the currency, but for now that relationship remains intact.

The key here is to be extremely vigilant and cautious. Do not chase things higher and make sure that you have your downside protected as either a dollar rally or a dollar capitulation could derail the bull's party but for now the trend is definitely your friend.