Momentum decay

Although the major indices gave back some of Tuesday's gains, it was another sedate day for the market on Wednesday. Once again, there was little to drive the market in either direction, and such lackluster action indicates slow momentum decay. While individual stocks continue to go up, many breakouts are prone to failure or stall post breakouts. That is why you get best risk reward when you can time your entry with beginning of a momentum cycle, August and September was ideal period for such entries. The other time to enter was beginning of November, when after a week or so of correction the market again accelerated.

The momentum decay we are currently witnessing can be interpreted both ways. The bulls will tell you that the market is taking a much needed rest as things set up for another strong run, while the bears will say that the lack of volume and sideways action is evidence that the buyers are tired and there is little cash left to send prices higher.

How long will the correction last and how severe it will be is the question.It can be for few months followed by rally in later half of 2007. Stocks react to one earning season and next season just stall or pullback followed by next earning season leading to rallies on surprises. You will often notice trend persist for long time and they normally end with a bang. As against that this rally is completely driven by skepticism. Do you remember the commentators and newspapers making the argument that Dow Jones is just 30 stocks when it made a high. Number of contrary indicators are indicating extremes, but the question is, is it "the top" or just a normal corection.

Since 2002 the top callers have been busy at work, the one constant is every week they say this is "the top", the arguments and the support for their thesis only changes. I remember in 2003 there were lot of folks (the same folks who are respected by media and clueless investors) arguing that it is just counter trend rally,look at Japan, same thing will happen again. Then in beginning of 2004 there was great chorus to say this is the end of America. In 2005 it was all about jobless growth not sustainable. In 2006 beginning it was about inflation and housing. Now in 2007 it will be about deflation! For last 4-5 years there has been a bubble in predicting recession.

The only constant during that period has been earning growths. Talk to any mutual fund manager, what do they care about, earning and growth. All this is background noise, it does not make money for the people who are making it and also those who follow it. The bears are never wrong only the markets are wrong. Some are wrong for entire 4-5 years of the move and the WSJ, Barron's and the CNBS's of the world continue to lionise them.

Regardless of your view of the market, keep in mind that trends have the tendency to be very persistent, and by most measures the current trend is up. There are plenty of fools who have not fully participated in this market and are sitting on the sideline in cash.With year end coming and for many career being at stake any buying here will be chased by most of them. It is easy to hatch a bullish conspiracy at this stage and pick the pockets of shorts. The dip buyers will not give up easily. When repeated attempt like that fail, the market will turn down.

This market has proven time and time again since 2002 bottom that, it will severely punish those who have bearish biases and very little clue about speculation. Every time they start calling the top and broadcast their bearish position and try and press their luck to the downside the market punishes them severely. The bulls have been right about this market since 2003 with orderly corrections followed by rallies, followed by correction, and so on. So be flexible in your hypothesis.

It is Thursday today, so keep your eyes open as to who amongst the prominent blogger will be the first to call for Monday plunge. If you keep doing it for 52 week, you will be right some Monday. Plus popularity in blogosphere is directly proportional to how bearish you are or how much you are under performing relative to S&P till date. Hundred years of market history and statistical evidence shows bullish bias is the right bias. Do you want to make money or do you want to fool around, it is your choice.

IDEAS