A Long and a Short for a Whipsaw Market

10/20/2011 7:00 am EST

Focus: STOCKS

Alan Farley likes the prospects for IBM following its third-quarter report, and sees a big online travel site as ready to head south. He tells MoneyShow.com that markets today aren’t necessarily any more difficult than conditions a decade or two ago, but investors and traders should adjust strategies to fit the market cycle.

Kate Stalter: I am speaking with Alan Farley of Hard Right Edge, and he is also well known to many as a regular columnist for RealMoney at TheStreet.com.

Alan, I wanted to start out by asking you: We’re in the thick of earnings season right now, and a lot of the financials are reporting. You have written extensively about the financials lately. Give us your take on that sector’s performance in the context of what we might expect from the broader market.

Alan Farley: The group has been underperforming. I think it is going to continue to underperform well into next year. It has really become sort of a cyclical play to banks.

The banks will do better when home prices go up. They don’t have the added earnings coming from the proprietary trading divisions, and they are just under so much regulatory pressure.

There are not a lot of good reasons to own the banks, and I think as long as the banks lag, the bond market is going to lag.

Kate Stalter: So, given all that, tell us what you are seeing in the broader market, and name some specific stocks or sectors that you think are showing strength right now.

Alan Farley: Yeah, the broad market is in this massive trading range, and I think it is going to stay in a massive trading range. We have discounted an awful lot of the European mess and debt downgrade here in the United States, and we have moved into a trading range that can last well into next year.

In this type of environment, you have to be a really, really good stock picker—and that is both on the long and the short side, because just when you think things are getting better they will turn around, and just when you think things are getting worse they will turn around and get better. That is the nature of a trading range, and that tends to shake out an awful lot of people.

I still like on the long side, and I know they just reported earnings, International Business Machines (IBM), which is down about $13 in the last couple of days. That is nothing for IBM. IBM just sells off after every earnings report. I think something like five of the last six or seven earnings reports, they have moved lower.

They always have high expectations into earnings and then they underwhelm in terms of their outlook, but then they overperform in terms of their outlook. I think IBM can still be bought. I think we are going to see $200 to $250 a share in 2012.

My other plays, more on the short side, there are some Nasdaq-100 stocks that are in big trouble, and those include Priceline.com (PCLN). Priceline, which has moved back to the top of sort of a four-week trading range, is butting its head against $500. I think that stock is probably headed to $350. So, I think that, for a long-term short sale, that is probably an excellent idea.

Kate Stalter: Now, a lot of what you write and in your coaching is designed for swing traders, Alan. But what is your best advice for traders and investors of all styles who are just really uncertain about what to expect over the next several months?

Alan Farley: Well, I think you have to be a market timer. I think this is not 2000 or 2005 anymore. Whether your call yourself an investor or a long-term buyer, whatever, I think you have to be a market timer.

That is the nature of having all of the electronics in the market, all of the computerized trading going on. We move according to very big cycles and very big swings, and if you happen to buy at the top of the swing they’re resistant.

Even as an investor, you don’t want to be down 5%, 10%, 15% of your position, just because you think the fundamentals are good. So, you have to pay a lot of attention to overbought and oversold oscillators, and these could be very long-term ones that run from one to three to five months, so that you are buying at the bottom of a relative strength cycle instead of buying at the top.

The same thing for profit taking. When you have been holding your position one, two, or three years and it’s getting time to perhaps take profits on it that you want to move aside, take a look at a ten- or a 15- or a 20-year chart, and see where the price is trading in relation to those very long-term prices.

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When you have a very strong stock coming up to a ten-year high, that ten-year high is going to be resistant even though it took place ten years ago. So, you have to use those long-term impulses even as investors these days. I think that is the only way to really survive and prosper.

Kate Stalter: Well, Alan, thank you so much for these views this morning. I am sure a lot of the readers will find this really helpful at this juncture.

Alan Farley: Sure. I love to help. And you know what? The markets are tough these days, but they are not necessarily any tougher than they were ten or 20 years ago.

They are just different, and you have to sort of make those adjustments in your strategies in order to adapt to the way the markets are acting this year and going forward.

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