How to Play Good Defense After the Big Move From TAXI

Ahhh... another day, another twist in the crazy story we call the equity market. Yesterday's optimism over a solution to Europe's woes was trumped today by a sharp (and surprising) plunge in consumer confidence. Valid reasons for a rally then a pullback? Maybe, though more likely they were just an excuse for traders to do what they wanted to do.

Still, the market's uptrend hasn't unraveled yet, so it's too soon for you to assume the worst just yet.

I'll update you on the saga in a moment. First, we have a little business to take care of.

Time to Play Defense With TAXI

Were you listening back on October 10th when we told you about Medallion Financial Corp. (TAXI), when it was trading at $9.90? I hope so. It's now at $10.98, and had been as high as $11.20 yesterday. Right now, it's up more than 10% from where we liked it, which isn't bad for two weeks worth of work on a fairly low-risk name.

Anyway, though I've still got a ton of confidence in this small cap (more so now than I did before, now that it's moving), this is a scenario where we need to start thinking strategically, and defensively. After all, there's a nice gain to protect.

The dilemma is double-sided. On the one hand, TAXI is going strong and could have much further to go before the bulls back off. If that's the case, bailing out now would get an owner out too early, and leave gains on the table. On the other hand, you never know what's going to trip stocks up [especially in this environment], and traders don't want to give up an unrealized gain just because Medallion Financial sells off while they're not looking.

The solution to the two-pronged problem is one of my favorite technical trading tools.... the parabolic stop-and-reversal indicator, or SAR for short.

Most of you are probably familiar with it, but in case you're not, I can sum it up real quickly - the SAR tool shows you where a trend has likely been broken.

On the nearby chart, the SAR markers are plotted in blue. Right now they're underneath the TAXI price bars, with the last one currently placed at $10.30. They rise each day though, reflective of the new uptrend. The 'reversal' aspect is simply the point where the stock brushes that day's SAR value and sends it back above the price bars - a switch to a bearish mode. If/when that happens, the trend is said to have reversed, which would be a smart exit point ...before any more gains are given back.

Now, I'm not saying $10.30 is the magic number (it changes every day anyway), nor am I saying the Parabolic SAR indicator is the only way for you to play good defense while still giving yourself a shot at playing offense. All I'm saying is that it's a simple, foolproof tool to keep yourself out of trouble when other clues may be misleading... including the tool between your ears.

The key criticism of the SAR marker is its simplicity. I get it. And the critics are right - it is simple. It's nowhere near as complex as a triple-smoothed momentum oscillator, or a PercentR acceleration score. In my experience though, the more convoluted an indicator is, the more prone it is to failure. I'll take 'simple' over 'complicated' any day of the week.

If you wanted to apply the idea of a Parabolic SAR tool, but don't have the ability to apply specific indicators as stops, many brokers now let you apply trailing stops. These exit orders work in much the same way, changing each day that your trade progresses, designed to automatically raise the floor on a position every day, but without requiring you to make an immediate exit that could get you out too soon.

Anyway, my bigger point was simply that we're really rolling with TAXI now. Though this was a longer-term idea, it's always good to get a strong start out of the gate.

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The Market's Test is Beginning

I doubt you're surprised the market is falling back today. On a close-to-close basis, since the 3rd, the S&P 500 had gained 14.1% as of the end of the day yesterday, and from the deep low on the 4th, the market had actually run 16.7% over the span of fifteen trading days. It was the biggest uninterrupted bullish move in the past ten months, and the fastest one we've seen since the middle of 2009. It was already pressing its luck as it bumped into key technical hurdles. So, to see it hit a headwind now shouldn't be a shock.

Here's the thing [and bear in mind this is coming from a short-term bear] - today's pullback doesn't undo the bigger-picture uptrend now in place. This is just a natural response to hitting the hurdles many of the indices hit yesterday; there should be a little bit of a pause here.

Just to better illustrate this idea, I'm not going to show you a chart of the S&P 500. Instead, I'm going to switch the discussion to the Dow and the NASDAQ, as both of them brushed (or got very close to) their 200-day moving average lines yesterday.... the grand-daddy of all moving averages. Frankly, it would be more worrisome if these indices blew right past those moving average lines without any hesitation whatsoever. At least with the worry we can see unfolding here, we know traders aren't dangerously giddy.

As long as the NASDAQ holds its ground above 2613 - where the 100-day average line is resting - it's still in the hunt for a true long-term rebound. Even a dip back to the 20-day average at 2554 won't be a deal-breaker for that bullishness though. Only a move under that mark would set off a bigger tumble to prior lows again ...though that's still my ultimate expectation. Hope I'm wrong.

In the meantime we just have to let the chips fall where they're going to while the bulls think things over. The end of the European summit tomorrow may meaningfully fan these flames one way or another.

Sit tight.