What's up with this market?

investmenttool.com Cover Story

This market has switched directions so many times its giving me airsickness.

Early in the week, the technology heavy NASDAQ fell into correction mode. At one point Wednesday, the market was well over 11% down from its all time high which occurred last week.

Let's check the scorecard.

On Monday and Tuesday, the Dow, S&P and NASDAQ pretty much went down together. The NASDAQ fell most heavily, having its largest point drops ever. On Wednesday NASDAQ still had troubles but the Dow Jones, flat until the point suddenly began to surge. Now last week money was flowing out of the old economy stocks of the Dow and into the new economy stocks of the NASDAQ. On Thursday money flowed into everything as the Dow set a record one day point gain, the NASDAQ surged over 100 points and the S&P piled on gains. On Friday, it was back to last weeks pattern with technology stocks up and the Dow flat to lower.

Are you airsick yet?

What this indicates is that there is a lot of volatility in the market. Where the volatility is coming from is a study in psychology. There are groups that think the NASDAQ is way over valued and must come down. There are some who have gone so deep into margin that any drop in NASDAQ brings on margin calls and forces them to sell shares. There are some who think the old economy stocks are over valued, some that think they are too low.

Confused?

People are not changing their overall view of the market on a daily basis. There are just some days where the ones with certain views predominate. Then there are the momentum players that try and figure out where the herd is going and try to follow to make money.

Most disturbing is the alarming rise in margin debt. People are running their margin balances so tightly that the smallest drop in share price forces them to start selling stock. This makes downward moves sharper. This is the same kind of problem that led to the 1929 stock price collapse.

What is different now? A lot. Margin requirements are much higher, and some reputable brokerage firms are raising the margin requirements on risky stocks. No matter how much some company with no profits goes up the first day there are some firms that won't let you margin those shares. The problem is there are small players that will let you play this risky game.

Another major difference is that the overall economy is much more healthy than it was in 1929, or in 1997 or 1998. In 1929 the economy was already in recession when the crash hit. In 1998 Alan Greenspan helped the world economy narrowly miss a financial meltdown and global recession. Certain OPEC members may be trying to bring bout a world recession, but the smart ones are already pumping more oil out of the ground.

Take a look at the Palm Pilot IPO. There are people who lost 40% of their money in a matter of days on that stock. Yet there are brokerage firms that will happily let your borrow against those shares and get into plenty of trouble.

The solution? Reduce margin exposure. I had too much margin exposure until today. I wrote covered call contracts against my Oracle shares that eventually closed $14 in the money. I let the brokerage take the majority of those shares because I wasn't comfortable being on margin. I could have bought the contracts out and stayed on margin. The problem is that Oracle is at an all time high and has a history of not staying there. My buying power is now on the sidelines looking for a nice dip to buy back in. I might miss the last few percentage points of this bull run, but if things get dicey, I'll be ready to make money on the bounce back.

Yes, margin lets you take advantage of market runs and make more money. If you abuse it, a bear market can leave you with no shares, no ability to make dip buys and owning more than you put into the account

Think about it.

Shmuel Protter
investmenttool.com

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