3 Rules You Must Follow in This Market

By Sam Collins,

Shutterstock photo

Stocks traded lower on Monday, with volume drying up as we head into the Labor Day holiday. This put the market into the hands of traders who in very thin trading ignored takeover deals and rumors, and instead focused on economics.

Personal income for July increased 0.2% and spending increased 0.4% - income was slightly less than expected and spending just a bit more. But core personal consumption expenditures increased just 0.1%, and that was slightly less than expected. The big jobs report for August is due on Friday, and several economists said they felt that the unemployment rate would jump to 9.6% from 9.5% in July, and that's what the market focused on yesterday.

Several deals made headlines Monday, including the offer by drug maker Sanofi-Aventis (NYSE: SNY ) of $18.5 billion in cash for Genzyme Corporation (NASDAQ: GENZ ). Genzyme rejected the deal saying that it was "inadequate." GENZ rose 3.4% and SNY fell 1.1%.

And the battle for the acquisition of 3PAR Inc. (NYSE: PAR ) heated up when 3Par said that the offer by Hewlett-Packard Company (NYSE: HPQ ) at $30 was superior to Dell Inc.'s (NASDAQ: DELL ) offer of $27 that it had already accepted. HP was the only Dow component to rise yesterday, up 1.5%, as it enjoyed the impact of an announcement during the weekend of a $10 billion buyback of its own stock. DELL gained 1.1%.

The U.S. dollar rose 0.3% against a basket of currencies. And Treasuries climbed with the 10-year note's yield at 2.53%.

At the close, the Dow Jones Industrial Average was down 141 points to 10,009, the S&P 500 lost 16 points to 1,049, and the Nasdaq was off 34 points at 2,120.

The NYSE traded 817 million shares with decliners over advancers by 3-to-1. The Nasdaq crossed 447 million shares with ahead by almost 4-to-1.

Crude oil for October delivery dropped 47 cents to $74.70 a barrel, as energy supplies are reported to be the highest in years due to the slow-growth economy. The Energy Select Sector SPDR (NYSE: XLE ) fell 76 cents, closing at $51.34.

December gold rose $1.30 to settle at $1,239.20 an ounce, and the PHLX Gold/Silver Sector Index (NASDAQ: XAU ) fell 1.28 points to 182.86.

What the Markets Are Saying

Traders who yesterday jumped on board the long side of the market on the opening were probably delighted to have a quick gain. But the problem was that the gain lasted for only several minutes before the longs were squeezed by short-sellers in a low-volume environment where just a relatively few traders can control the market for a day or so.

Those who trade stocks for a living are very familiar with the high volatility that accompanies a pre-holiday week, and they use that to their advantage.

Yesterday was the fifth consecutive day that the S&P 500 traded within the narrow zone of 1,040 to 1,065. Yesterday's high was 1,064.4 and its low was 1,048.79.

Where then should a trader try to position longs if the evidence is for the near-term trading trend to be bullish?

Here is the answer from yesterday's Daily Market Outlook , "Why do I mention the 1,040 support line again after harping on it for at least two weeks? Because some of our readers wondered why, after being on the bearish side of the market since late July, I should suddenly (in their minds) turn bullish and call for a trading bounce. The reason is very simple: Support lines usually support and resistance lines usually resist. And they function best when the majority of the public ignores their significance and goes with the near-term trend."

With the spread of 1,040 to 1,065, the "smart trader" who is operating in a volatile market will try to position at some point below the halfway mark of the established daily spreads and not "at the market, on the opening." Trades should be entered at no more than 1,052 with a stop-loss at under the two daily reversals at 1,040 - say at 1,037. And only limit orders, not market orders, should be entered when opening trading positions.

Why do I bring this up today? Because I read the e-mail responses to the Daily Market Outlook, and it seems that some of you jumped on the long side yesterday at the opening, at the market.

If you trade, you must have some basic rules, and yesterday provided a great lesson in trading discipline.

Here are some basic trading rules:

1. Determine the trading spread in a volatile market and only take long positions that are priced below the halfway point of the spread (shorts are the opposite).

2. Always use a limit order. Never initiate a new position with a market order.

3. Always enter a fixed stop-loss order at a point below the daily spread or support line that, if violated, could mean that the near-term trend has changed.

One of the best traders once told a class of trainees, "your first lost is your best loss." That's true only if those who day trade learn from their mistakes.

For the remainder of the week, I'll cover some other basic trading techniques. Tomorrow's topic will be how to learn from losses.

To see the support zones and resistance zones of the S&P 500, click here .

Today's Trading Landscape

Earnings to be reported before the opening include: China Gerui, Dollar General, DSW, Energy Conversion, Isle of Capri and K-Sea Transportation.

Earnings to be reported after the close include: ABM Industries, Accuray, Applied Signal, Concurrent and Danaos.

Economic reports due: ICSC-Goldman Sachs store sales, Redbook, S&P Case-Shiller Home Price Indices, Chicago PMI (the consensus expects 56), consumer confidence (the consensus expects 51), State Street Investor Confidence, FOMC minutes and farm prices.

If you have questions or comments for Sam Collins, please e-mail him at samailc@cox.net .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing Stocks
Referenced Stocks: DELL , GENZ , HPQ , SNY , XLE

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Sam Collins

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