“Buy the dip” is among the most brilliant stock market strategies ever developed. It works well since profits mounts as prices recover. Each dip offers an opportunity to increase wealth.
There’s a big problem with that strategy. There’s no way to know when a dip is a dip. Sometimes, a dip is the beginning of a bear market. And sometimes bear markets last for years, or even decades, as the current bear market in Japan demonstrates.
Dip buying has led to losses for most of the past 32 years in Japan. Although that’s an extreme case, it does show the risks of buying the dip.
As stock market volatility increases, it’s time to consider whether or not the current action is a dip or not. One clue can be found in the behavior of the market.
Dips are short breaks in the uptrend. Stocks generally continue to show the same trend in a dip they showed before the dip. Recent market action has shown some troubling departures from the trend.
Sectors that led the bull market for the past year have been the biggest losers over the past three months.
Sectors With The Most Market Rotation
Market Rotation Shows “Smart Money” Is Taking Profits
The chart above shows the sectors that make up the S&P 500. The list is sorted based on performance over the past 12 months. The sectors with the largest gains in that timeframe are the sectors with the worst performance in the past three months.
This indicates that large investors are taking profits. They are, in effect, saying that the bull market has taken tech stocks to extreme overvaluations, and it’s time to get out. That makes sense.
Market rotation is a sign that the smart money is selling. Now could be the time to follow the smart money and take some profits to avoid the bear market that seems increasingly likely.
Until tech stocks lead the market, risks are high and conservative strategies should be rewarded.
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Michael Carr is a Chartered Market Technician for Banyan Hill Publishing and the Editor of One Trade, Peak Velocity Trader and Precision Profits. He teaches technical analysis and quantitative technical analysis at the New York Institute of Finance. Mr. Carr is also the former editor of the CMT Association newsletter, Technically Speaking.
Follow him on Twitter @MichaelCarrGuru.