Click chart to enlarge

The chart above is a chart of SPY, which tracks the S&P.  It is in the same place as it was 6 months ago, which we predicted in our last post.  We didn't know what path it would take to get back here, but we did know that it had no upside.  Why?  The Obama tax code is designed to support the lazy and hurt the ambitious.

Here's the math...

For the average New York family making less than $217k, the taxes are as follows:

Federal income tax: 28%

Social Security tax: 10.4% + 2% at maturity = 12.4%

Medicare tax: 2.9% + .6% at maturity = 3.5%

NYS income tax: 6.9%

NYS sales tax: 8.63%

Real estate tax: 5%

Total tax: 64.43%

With 2/3rd's of their income going to taxes, and nearly all the rest going to health insurance, the average self-employed New Yorker earning $200k a year gets to keep about $17,000 of their earnings.

In contrast, the average New Yorker making $17,000 a year gets to keep 100%, or $17,000 of their earnings.

When you consider that the lifeblood of America's economy is its small business owners, it hardly seems efficient to take their incentive away.





Dangerous Territory

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Sorry for the brief hiatus, hope everyone checked in at least 3 times a day in our absence!

Back when Merrill, Lehman and Bear Stearns collapsed, we spoke to the CEO of a company which was hired to figure out what went wrong. We ask many people where they think the market "should" be. For some reason, his answer stood out... "on both sides of 11,000, but it will keep coming back to that number for years to come."

We've felt the same way for a long time now. There's no reason for the market to be as high as it was before the crash. Sentiment is nowhere near that level of euphoria. Nor is the economy. So that rules out us being able to sustain anything in the 13,000 to 14,000 range. Nor should we be at 8,000. We belong at 11,000. Maybe 11,500.

For anyone that's followed the basic teachings of this blog, the chart above shows three reasons why one would be lightening up on shares in the near future. The market is

1.) At the top of a trend channel, far from its moving average

2.) Near a very significant resistance level

3.) Blowing off at the top of an S-curve

Sure, it could go higher, and it probably will. But now would be a good time to be 80% in cash.

If someone were to buy into any one of the indexes on Monday, it's extremely likely that they will be back to break even in a few months time.

Without knowing what path the market will take to get back to Dow 12,700 in 3 months, we just take the easy route and let it tell us. We're 86% in cash. If it goes higher, it's a no-brainer short and hold. If it drops, we scale in. There's no need to predict anything. Well, anything other than that we're in dangerous territory now.

VECO

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Piper Jaffray analyst Ahmar Zaman took over coverage of VECO on July 15th, reducing the firm's rating on the stock and slashing both its price target and EPS estimates. He cited "uncertainties around order momentum" as the reason behind his actions. On the 15th and 16th of July, VECO shares lost $5, or approx 11% following Piper's downgrade.

With VECO's report yesterday, we see that the company is doing far better than Zaman expected, and its guidance negates any of Zaman's fears.

But were they really fears at all, or is something else going on?

Ask yourself the following questions...

Is Zaman completely and utterly inept after years of expensive education and office experience?

Can Zaman do the third grade math required to make the right call on the LED sector?

We happen to think that Piper Jaffray (and all other Wall Street firms) know the deal.

They want lower prices.

So is Zaman incapable of conquering third grade math, or did Piper want to pick up shares of VECO as cheaply as possible ahead of its earnings report?

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To answer this question, we need only to look into Piper Jaffray's recent past.

In 2005, Piper agreed to settle with the SEC, NASD, NYSE, NASAA and the New York Attorney General in a landmark securities fraud case in which Piper had released "biased research designed to benefit its own business."

If you google "piper jaffray fraud", you will be astonished at the sheer number of these incidents.

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So what should we believe happened this time? Should we believe analyst ratings? Should we follow financial "news"? Is it designed to help the retail investor? Are they just being good samaritans, pitying the little guy and lending him a helping hand?

Part of the purpose of this blog is to expose how Wall Street really works, and leave you to draw your own conclusions.

CREE

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CREE broke out from its multi-month consolidation, which bodes well for the LED sector, as well as for the broader market. This is not a guarantee that the market will begin a new leg up from here, but it is yet another sign that the bulls are coming on very strong in the tug-of-war for control of the market. Even though CREE is not near 52 week highs and is not posting the largest percentage gains of the stocks in the LED space, it still is the leader of the sector. What the leader does, the rest of the stocks in a sector will do.

Now that we're quickly closing in on LED earnings, (RBCN on Aug 5 & CREE on Aug 10), we're hoping to be blessed with some upside that allows us to exit all or part of our positions before the earnings are released. Lightening up on shares that rally ahead of earnings is a win-win situation. You make your profit and avoid the risk of an earnings miss. Only in rare occasions will you miss significant further upside. Over the course of an investing career, it is better to miss these rare upside moves than to repeatedly participate in 50% gaps to the downside.

APKT

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Acme Packet is a company that provides border control solutions. It was started in 1866 by Wassily Wassilyevich Kandinsky. They currently own and operate over 14,000 lookouts along the US-Mexico border and an additional 12 along the US-Canadian border.

Actually, none of this is true, but it really doesn't matter. All we see is a stock that is above an uptrending moving average, holding its own despite a weak broader market, trading within a trend channel, at all-time highs. Both its quarterly and annual earnings show steady growth.

On a pullback to the bottom of the channel (below 29), which could happen tomorrow morning, it may make for a good short term trade on the long side.

We don't have the same confidence in APKT for the intermediate term as we have with the LED sector, but for a quick trade it makes little difference.

RBCN's Channel

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Above we've posted a chart of RBCN now that its channel is becoming more clearly defined. We're using a 55 day moving average, because it best fits the chart. The fact that the average parallels the computer-generated linear regression line (shown in yellow) confirms the angle of the chart's ascent. It is at this point in a company's growth cycle (4 to 5 months in) where we start scaling into and out of our position based on the stock's position in its channel. With the stock at its neutral centerline, there is no reason to buy nor sell. If the stock drops to the green line, we add. If it rallies to the red line, we take some profits. In theory, when the stock is at the green line, you should have 100% of your intended position. This does not mean you should have no available cash. When the stock is at the yellow line, you should have half of your position. When it is at the red line, you should have no position. There are lines at the 25% and 75% marks as well, which we have not drawn. By scaling into and out of the position within the channel, one can increase profits and limit risk. We do not follow these rules verbatim. We like to maintain a 20% to 25% position in a strong stock even when it reaches the red line. Conversely, we only hold a 75% to 80% position when it corrects to the green line, allowing for intraday spikes below the line caused by the action of the broader market. However you choose to trade a stock, you should know that in most cases, it serves a trader well to coordinate their exposure with the stock's relative position in its channel, at least to some extent. We've many times sold entire positions in stocks blowing through the top of their channel, figuring we'll always be able to buy it back cheaper at some point in the near future. In over 90% of cases, this holds true. The top of RBCN's channel is at approx $37 right now. If it surged to $38 or $39 in the next few sessions, we would sell. Our money could be put to better use elsewhere while waiting for RBCN to come back to the yellow line, which it most likely soon would.

Crime Pays

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The chart above is that of Goldman Sachs, which is rallying in response to a settlement on its recent fraud case. Goldman Sachs was accused of defrauding investors out of $1B, although many sources believe the figures are a lot higher. In true SEC fashion, Goldman is being fined half that amount. It is yet another shining example of how crime pays, as long as it's white collar crime. Throughout its history, the SEC has allowed companies to profit from their crimes. An incentive for fraudulent practice? Only on Wall Street.

RBCN

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Ever wonder what would happen to the stock chart of a company whose top brass all liquidate their positions in unison, followed by a nearly 10% correction in the indexes in just 9 sessions?

The chart above is just that. RBCN is the perfect example of why you should listen to the chart and not the headlines.

We updated our performance on the left side of the blog today, and while we basically have the same amount of capital we had in mid June, the market has fallen approx 5% since then. We consider this a substantial gain for us, as all performance is judged relative to the indexes.

RBCN remains the relative strength leader in the LED space. There may be other companies with lower P/E's, higher EPS's, higher PS ratios, etc, but compared to the importance of relative strength, none of that matters. If you make your approach to investing as simple as Nick Darvas did, you will find that all of the information you need about a company is in its chart. Fundamentalists completely reject this thinking, preferring to live in an ivory tower of complex formulae and psychological theorem. Most of the strict fundamentalists that we know are no longer investing in the market. They just couldn't beat it on a consistent basis. Instead, they publish books on how to beat the stock market... go figure.

CREE

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Has there ever been a more perfect descending triangle than this one? CREE has held its $60 support level in a textbook way, while putting in lower highs over the past 3 months. Triple and quadruple bottoms never hold, so we have to bet on the odds and say that it's only a matter of time before CREE breaks support. We happen to own it, but are holding onto it anyway. We're looking to buy more CREE, as we feel it's quickly approaching fair value. The confluence of events (falling share price and rising EPS) are shortly going to meet head on.

If the broad market (Mr. Market) continues to fall, it may even give us a below value price on CREE! We'd be backing up the truck if that happened, in keeping with our theory that the LED's haven't seen their highs yet.

The quick math on CREE...

CREE's EPS is somewhere around $1.68, soon to be $1.93.

A fair P/E for CREE is approx 25, in line with its 20% annual growth rate

25 x $1.93 = $48.25

So if CREE drops another 12 points, we could quickly see a rush of buying that brings it back into the 60's in just one or two sessions. Whether you're a day trader, an intermediate term trader, or a long term investor, you should keep your eye on CREE because it may soon offer the trifecta...

1.) Growth

2.) Value

3.) Popularity

Company Growth Cycle

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The chart above is a random chart of a typical company's growth cycle. Unless you find the next AAPL or GOOG, you'll find that this cycle typically only takes about 2 to 3 years to run its course. The numbers on the chart do not correspond to the Stages (1,2,3 and 4) that we often mention when talking about what part of the growth cycle a chart is in. We just put them there to divide the chart into 3 phases to help explain what happens to the valuation of the stock as it makes its way through the cycle. All of the figures below are just a ballpark, and may vary widely from one specific stock to the next.

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In phase 1, a company hardly has a positive EPS. It may just be coming off of several negative quarters. Its market cap is low, and its volume may even be low. It's P/E, however, may be very high. This is the period when investors know that the company will be a huge success, but they aren't quite able to figure out just how large its potential really is. The stock may have an EPS of .17, but analysts are predicting that the company's EPS a year later will be anywhere from $1.10 to $1.45. Confident that the company will earn at least $1.10 during the next fiscal year, investors apply a P/E of 30 to this hypothetical future EPS, giving it a price tag of $40 or so. Of course a stock in this early stage with an EPS of .17 and a price of $40 appears to all of us to have a P/E of 235. This keeps all but the most daring of investors away, but it's actually a great time to discover the stock.

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In phase 2, enough time has passed that investors are better able to understand the size of the company's market, its competition, the potential for its technology, etc. At this point, the stock trades at a more reasonable valuation, as the future of the company begins to come into focus. Future earnings become more predictable. The company may be earning $1.50 a year, with prospects of earning $1.85 the following year. Its P/E may now be around 40, and it'll have a price tag of about $60. All of the math will now make sense, luring investors that seek a combination of growth and reasonable value.

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At the end of phase 2, when the stock hits about $75, something happens that makes investors realize that the earnings growth of the company is not sustainable. There are many reasons this may happen. The stock will start selling off strongly as investors start recalculating its valuation. During this phase, the stock is not only being valued with lower EPS forecasts, but a lower P/E as well. The company, currently posting an annual EPS of $1.80 may be forecast to make $1.95 the following year. Even though it is still growing, it will not be making the $2.20 investors had previously counted on. To make matters worse, its P/E now drops to 12 because it's expected that the company's annual growth rate will drop from 30% to about 10%. Consequently, the stock's price drops quickly to $23. From there, the company just becomes forgotten, and the stock slowly makes its way to 40 cents.

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This is what we can learn from the chart above...

-You should know that all of these realizations that investors have about a company come about 9 months before any of it is evidenced in the earnings reports or news reports.

-Ideally, you want to discover a stock when it's in the first phase. The P/E will seem outrageous during this phase, but the earnings will quickly catch up if investors are right about the company's prospects.

-If you find out about a stock during phase 2, you can still profit, but it's a more dangerous game. You must sell if the stock makes a simultaneous and decisive break of its trendline and moving average. This kind of explosive breakdown more often than not marks the start of phase 3.

-You should never fall in love with a stock. If you're one of the investors buying the stock after it enters phase 3 (thinking you're getting a great deal), you're in for a big suprise. When people say "buy low", they don't mean to buy a stock locked in a downtrend during a strong broader market. They mean buy a strong, uptrending stock during a selloff in the broader market.

-The time it takes for a stock to make its way through this entire cycle gets shorter and shorter with each generation. People do not have the attention span they had decades ago. Our guess is that all of the Ritalin-addicted kids today will soon control a market that completes this entire cycle in under a year's time.

-"Buy and hold" does not work. Unless you're lucky enough to find the next AAPL, holding a stock for the long term will destroy your portfolio, which leads us to a Snotism...

-All stocks eventually go to zero.

Relative Strength

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There are a myriad of ways to calculate relative strength. Many software packages have their own formulas for scanning through charts and assigning relative strength values to them. Investor's Business Daily (IBD, also short for inflammatory bowel disease) includes a figure for relative strength in its listings.

But you really are better off without all of the fancy formulas and calculations. Because we're honing in on just one or two hot sectors at a time, we find it far more reliable to just watch the top 5 stocks in the sector/s on a daily basis. This gives you a feel for the stocks, which you don't get by relying on relative strength figures.

Relative strength, in its purest form, is simply a comparison of a stock's performance relative to a baseline. The baseline should be diversified, so the indexes are used. A quick glance at a group of stock charts is all you need to pick the relative strength leader. Times of broad market weakness are not only the best times to compare relative strength, they're also the times when you'll do your buying. So while you may not like market corrections, they are an essential part of your success, and you should eagerly await them.

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We've posted 4 charts above. The first is our baseline, the Nasdaq. You could use any index for this, but we chose the Nasdaq because its moves have been textbook, from its nearly perfect S-curve to its nearly identical double bottom.

The S-curve started off this whole "Big Fat Greek and then some BP worst environmental disaster in U.S. history" correction. Once we were in it, we had no choice but to use it as a way to ferret out the highest relative strength LED issue.

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In chart #2, the chart of CREE, you'll see that CREE's bottoms roughly align with the bottoms of the Nasdaq. That is, they are all kind of in the same area. CREE's relative strength is flat. In other words, it is just mirroring the moves of the market, nothing less & nothing more. Of course it will move at a higher percentage than the index, but relative strength does not factor in percentages, it merely distinguishes between which stocks have buyers and which don't.

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The chart of VECO shows a stock with weak relative strength. Each low was lower than the last, despite the broader market being able to hold its bottom. Once our top holding, we sold VECO when its relative strength came into question. With Friday's performance, VECO is redeeming itself. We will only know in hindsight if VECO's severe correction was just a panic, or company-specific problems. Its fundamentals still appear strong, but we feel that we're better safe than sorry... where there's smoke there's fire. We may repurchase VECO at some point, but are still concerned that its weakness during the correction may be a window into some "behind the scenes" issues.

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The last chart is a chart of RBCN, which swept us off our feet during the correction. Each low was higher than the last. Charts that exhibit this kind of strength during periods of market weakness are the first to make new highs when the market turns around. They also most often do tremendously well during the subsequent bull run. The mechanics of it are simple... there are few sell orders during the months of the correction. For whatever reason, people want to hold this stock. So when buyers return to the market, the buy orders overwhelm what few sell orders exist, and the stock rallies strongly. The reason people don't want to sell this stock (or any other stock with high relative strength) is typically not known to the retail investor for several quarters. We are not privvy to the boardroom discussions, factory visits, wildly complex formulae, and other shenanigans that go into determining which companies are poised for explosive growth. Despite being left out of all of this, they do inadvertently give us a very valuable treasure map... the chart.

"Professional" Performance

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We feel like Andy Kaufman on the set of Saturday Night Live... "Do Latka, Do Latka!"

So here's your token chart of RBCN's breakout, complete with volume. Our guess is that as long as the market doesn't tank, RBCN will retrace a bit and then take off again.

But this post isn't about RBCN... it's about actual "professional" stock market performance.

The market has been flat over the past 10 years, trading at or about 10,450 in June 2000 and in June 2010. This makes it the perfect time frame to compare mutual fund performance, against an unchanged index. So here's what the "pros" have done with your money over the past decade...

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Vanguard Life Strategy Growth Fund

+ 1.48%

Vanguard Life Strategy Moderate Growth Fund

+2.75%

T. Rowe Price Growth Stock Fund

+.77%

T. Rowe Price Midcap Growth Fund

+5.94%

Fidelity Blue Chip Growth Fund

-1.84%

Goldman Sachs Capital Growth Fund

-2.20%

Goldman Sachs Strategic Growth Fund

-2.67%

Goldman Sachs Structured Large Cap Growth Fund

-5.29%

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So there you have it, a random sampling of growth fund performance over the past 10 years. Those burdened with the inclination of trusting the "professionals" to manage their money over the past 10 years have done exactly what the market has done, on average. These are the lucky ones. Others burdened with the same inclination found themselves invested with Bernie Madoff and similar cretins.

We don't have 10 year figures for our own performance, but using what we do have thusfar, we're up 17.9% over the past 2 years, for an average of approx 9% annually. If you believe it's not fair for us to compare our 2 year performance with their 10 year performance, you only need to look at what the market has done over the past two years. It's not flat as it was for their period. It's down about 17.5%.

So there you have it... the "pros" that haven't been caught are serving up flat returns and making huge fees for their "services". Those that have been caught are serving life.

Can anyone give us any good reason why someone would invest with the "pros"?

RBCN Breaks Out

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All of the relative strength (resistance to decline) that RBCN has been displaying over the past several months has proven to be an overwhelming force, exposing itself in an incredible breakout to new highs today. To say the least, these highs are coming long before the market posts its own new highs. The theory we have that relative strength is the most important indicator of a stock's intermediate term success has been shown to have real predictive value with RBCN's breakout.

We bought more RBCN this morning at just under 29, putting our portfolio at a point where we're just about 50% invested. There's no guarantee that the broader market has seen its lows yet, hence the other 50% we hold in cash.

For those of you thinking you've "missed" RBCN... think again! Today's action is a very strong signal of the health of the stock (and the company), and bodes very well for its near term (3-4 month) performance. If we did not already own RBCN, we would buy 25% of our intended position here on the breakout and wait for a pullback (approx 50% of the breakout's magnitude) to buy another 50%. The last 25% would be bought if the broader market corrects to new lows, pulling RBCN back below resistance.

We may still buy more on the pullback ourselves. Conversely, there is a point at which we'd sell some of our shares if the stock continues to rally strongly over the next 2 to 3 sessions. This is unlikely, but it does happen.

In almost every case we've seen where a stock breaks out to new highs strongly while the market is just beginning a turnaround from a correction, it has been just the beginning of a very impressive bull run for the stock. It should be noted, though, that the breakout is almost always met by a retracement which can be substantial, as momo traders buy and sell the breakout without any intention of holding for several months, or quarters, the way intermediate term investors do. This retracement of the breakout is often reversed very quickly, as would-be buyers see it as a second chance to get on a train they thought they had missed.

As long as the broader market doesn't sell off significantly, it's our guess that RBCN will rise steadily for the forseeable future.

RBCN

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RBCN looks as if it's inside an ascending triangle, perhaps at the top of a high-flying flag. We don't put much emphasis on recongnizing all of the several thousand various chart formations because people that do so lose credibility very quickly. There are really only a small handful of formations a chartist should be aware of, and the triangles are one of them. Even if you want to shy away from putting a fancy name on them, you should note when a chart is bound by resistance and support levels, particularly when either of the two are ascending or descending. These patterns are merely a map of current investor psychology (sentiment), which is why certain formations appear time and time again.

Right now, the chart of RBCN is telling us that each time the stock sells off, traders are hell bent on not missing the next bottom. So much so, that each bottom is higher than the last. In other words, they'd rather pay up for the shares than miss the train. Most ascending triangle patterns break to the upside. Not always, but most of the time this is the case. If RBCN shows signs of an imminent breakout, we may be buying more of it despite having to average up. This is because during this current period of great instability in the broader market, RBCN's performance has thusfar been unwavering. If everything we preach on this blog about relative strength is true, stocks like RBCN that resist the decline make the best investments when the market turns around.

Relative Strength

Any questions?

Tony Hayward

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BP CEO Tony Hayward:

"The overall environmental impact will be very, very modest."

"We will mount, as part of the aftermath, a very detailed environmental assessment."

_________________

Facts:

-The Exxon Valdez spilled 11M gallons of oil, contaminating 1,300 miles of Alaska's coastline.

-The BP Gulf of Mexico oil leak is estimated to have spilled anywhere from 20M to 175M gallons of oil thusfar.

-The coasts of Texas, Louisiana, Mississippi, Alabama and Florida are expected to be impacted by the disaster. This includes the Everglades, along with 7 other national parks.

-The BP Gulf of Mexico oil leak is already being called the worst in U.S. history.

Relative Strength

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The graph at the top shows the relative year-to-date (YTD) performance of the indexes and the LED stocks we've been following. The chart at the bottom shows how far off each stock is from its recent highs. While the indexes are basically flat for the year, the LED stocks are still way ahead of the game. This may be little consolation to those who bought in more recently.

Another thing can be deferred from these charts, and it happens to be the most important thing going ahead. One stock stands out as the clear leader in relative strength... RBCN.

RBCN has not only outperformed the others on a YTD basis, it has also fallen less than any of the others from recent highs. This is spectacular when you consider how contradictory this is. The stocks that do very well (have the highest momentum) usually correct the most. RBCN has managed to post impressive gains AND resist giving them back. This leads us to believe that the stock is in strong demand, and will emerge from this correction with explosive strength, posting tremendous gains over the next several quarters. It is our belief that smart money is flowing into RBCN, giving it its incredible resistance to decline. In an ideal world, we would now be blessed with a few sessions of capitulative selling which brings RBCN into the low 20's or high teens, at which point we could back up the truck. Opportunities like this are rare, but in a nutshell, they are what the other 70% of our portfolio is for.

This all takes great patience, but in time it will all make perfect sense.

VECO

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VECO & AIXG fell today, supposedly on "news" that Applied Materials and Samsung are going to enter the MOCVD market. We frankly don't care what the "news" is, or what it means to the company. All that matters to us is the chart and the earnings. The chart has been showing increasing signs of waning strength versus the other LED issues. We traded in almost 2/3rds of our VECO holdings for shares of CREE and RBCN yesterday based on this relative strength issue. We did not have advanced knowledge of today's impending "news". Approx 12% of our portfolio is still invested in VECO. So where do we go from here?

First we look at the chart. The chart is at a very critical point, resting on a fairly long term trend channel. This trend channel was reiterated by its moving average until its recent rally took it well above its normal trading range. So we don't have a moving average to rely on, but we do still have the channel. Either VECO will rally strongly from here, solidifying the support its channel has created, or it will break down hard. One of these outcomes could happen as early as tomorrow, or it may happen after the stock trades around this support area for some time.

Either way, our discipline is certain... we let go of stocks that break down hard and close at their lows (intraday spikes don't count, especially if brought on by a spike in the broader market). Regardless of what they do after decisively breaking down, we sell and never look back. We try to always look to the future rather than dwell on the past. Right now, until/unless they follow suit, CREE and RBCN look very strong relative to the market, and we will continue to buy them on dips instead of buying back into VECO.

The psychological aspect of this is as follows... stay focused on the goal. The goal is not to have made a good trade on an LED stock, namely VECO. The goal is to double the money you've invested in the LED sector during the craze before it's over... then find the next craze and do it again. Finding the stock that will make that happen is never easy. Nor is the discipline required to trade in a way that will make that goal a reality. Keeping your capital invested in the highest relative strength stocks in a strong sector is a sure way to beat the market. But you have to be flexible, and remain focused on what your bottom line will be in December, not what it will be next week.

We will continue to closely watch CREE and RBCN for signs of high relative strength, or waning strength, whatever the case may be. As for now, neither stock is disappointing on that level. Although both are off their highs, they are both higher than they were on April 1st, which cannot be said about VECO, MRVL, AIXG, or the indexes.

Relative Strength

Periods of market weakness are the best times to judge a stock's strength, especially relative to others in its sector. Yesterday, VECO was the relative strength winner in the group. Today, CREE and RBCN are coming on strong. One day does not make a trend, so we'll have to keep an eye on this race. We feel that relative strength is the single most important characteristic a stock can have, and that it is therefore the greatest predictor of future performance.

If CREE & RBCN continue to outpace VECO (not in gains but in strength relative to the market), we may just shift our position from VECO to a combination of the two. It's too early yet, but there's no doubt at this point that CREE, RBCN and VECO are far outpacing their weaker counterparts, AIXG and MRVL. Now with only three stocks in the running for "highest relative strength LED issue", it shouldn't be too hard to choose which will be the top dog during the market's next leg up.

VXX

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Some time ago, we predicted that the market would trade in a wide range for the next several years (something like 7,000 - 10,000). We still believe this, and given recent events, we believe that the market just put in the top of this range. Now to find out where the bottom will be!

We ran into two of our well-respected Wall Street hedgies this weekend and asked them both where they thought the market was headed. One is a long term thinker and his reply was, "over the next 4 to 5 years... much higher". He did not seem in the least bit concerned with what happens over the next few months. The other told us that he sees the market going much lower. He admitted, though, that he was on the wrong side of the trade during the market's recent upside. He said he's been a bear on the market for a long time, and continues to be. He suggested not choosing sides and instead trading the VIX.

Given that our chats were inconclusive (one bull and one bear), we have to rely on our own spidey sense. Our guess is that given everything the market is facing right now, it'll drop to about 8,000 or so (lows of last summer), to mark the low for its new trading range. But that's just another two days of trading, so why fret?

We probably should not be 33% invested at the moment, and we may trim that percentage a bit if the market rallies. Otherwise, we're just going to remain focused on the intermediate term (end of year), and use this time to increase our exposure in companies with great promise. We still stand firm on our belief that the LED stocks will double by year end from whatever lows they make during this correction. Perhaps CREE from 55 to 110, or VECO from 35 to 70, whichever it may be, that's too large a gain to miss out on. We still strongly believe that these stocks have not put in their tops just yet, and that belief is rooted in our theory that they will not top out until a few quarters (or a year) before their earnings growth tops out. Given the size of their market, we don't think they've reached that point yet.

That said, we're still not willing to pay up for these names. We want them cheap. If the market drops 800 points one of these days, we'll be buying, not selling.

Along with our focus on buying low, we're also going to take hedgie #2's advice and play with the VIX. For those unfamiliar with trading the VIX, you should know that you cannot but the VIX directly. Instead, there is an ETF called VXX which tracks it. The chart above is a chart of VXX.

After the market calms down for a few sessions, this index will drop. During market corrections, the VXX goes sideways in a broad range, making very rapid swings from its lows to its highs. This makes it a great trading vehicle. Buying VXX anywhere in the low 20's looks to us to be a sure winner over the next couple months, as we agree that market volatility is here to stay until at least the next quarter. Buying VXX in the low 20's (if possible), is perhaps the best insurance policy against a market crash. There is little downside, because for it to drop significantly, traders would have to reach a point of complacency. Given the events overseas, our own struggling economy, and the market's recent large gains, we just don't think traders are going on vacation anytime soon.

For better or worse, here's our prescription...

-Cash is King. (have at least 2/3rds of your portfolio in cash).

-Use this correction to get bargains on strong growth stocks that you plan to hold until year end.

-Hedge your portfolio with a bet on continued volatility by buying VXX on dips.