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Warning Signs: How To Properly Trade A Long-Term Bearish Outlook

November 12, 2009

The bearish arguments these days are lost–drowned out by the buy and hold boys who monopolize the business media with their bullish rhetoric. Their tone is conservatively described as optimistic, and perhaps more realistically it sounds almost euphoric. After coming back from the brink of their complete demise, they are pounding the table with a little “I told you so!”  Remember one thing if you are a trader, you do NOT have to buy and hold. However, the mutual fund crew MUST buy and hold, and from a business perspective it is in their best interests to encourage investors and traders to do so. I for one believe this market is but a castle built in the air and ripe for a thrashing. That said, I am unwilling to go full bear here. I prefer to go in and out–long and short with little exposure and lots of cash at this point to reduce risk.  Renowned short-seller Doug Kass presents his view on the naiive optimism in the stock market: http://www.cnbc.com/id/33887718

How to play it: If you are long keep your trailing stops roughly 10% from the current closing price of the index, or 10% on each stock in your portfolio that is above its 50 day moving average. Aggressive investors can trim exposure here and wait for a pullback to re-enter, or they can short with a 5% stop to the upside with 10 or 20% exposure. In my opinion the 200 ma still serves as support, and until the 200 ma is broken decisively for at least a week to the downside, I wouldn’t take full short positions (ie net 50% short or higher).

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