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Three Things You Need To Know Now
By David D. Moenning

We need to have a plan for the bottoming phase, which may have started on the eventual recovery phase of the market.

So we'd talk about a couple of the things to be aware of and what to be looking for.

The Tail vs. the Dog
The first thing that is vital to understand right now is that the credit markets are the dog here and the stock market is the tail. So, if you plan on watching only the action in the stock market going forward, you will be focused on the wrong part of the animal.

Remember, this is a credit crisis first and an economic problem second. Thus, it is vital to pay attention to what is happening in the credit markets in order to gauge the status of the problem in the stock market.

So, it is probably a good idea to take a few moments each day to take a peek at the credit markets. Pay attention to the LIBOR rates each morning. In dollar terms, LIBOR needs to get back to normal in order for the banking logjam to break. Look at T-Bill rates as they provide an indication of the "flight to quality." We need to see these rates rise in order for say things have calmed down. And if you can, listen closely to what is going on in the commercial paper markets. Look for rates on 30-day commercial paper (non-bank) to bet back down below 3%. Because, in short, stocks cannot improve until these three areas improve.

The good news is that governments and central banks around the world are working hard to come up with fixes for the credit problems. And it is a fairly safe bet that the combined actions, which have been nothing short of extraordinary, will succeed - eventually. But, we also need to recognize that there is no quick fix here. It will take time for the deleveraging of the financial system to occur and for confidence to return.

Know Your Crash Patterns
As we have said a time or two, our goal is to keep portfolios "in tune" with the market environment. The first step of which is to be able to identify the type of market you are dealing with. And believe it or not, the fact that we know we've got a waterfall decline - or crash - occurring is helpful because we know what to look for next.

If you are interested, pull up the charts of the market bottoms from 1987, 1990, 1994, and 2002. You will likely see a pattern that repeats. Once a bottom has been put in, which is usually accompanied by massive volume, the market then embarks on a very violent bounce higher. This move, often called a "dead cat bounce," will be short-lived and be followed by a "retest" of the lows.

This pattern is rooted in emotion. You see, investors will, at some point, realize that the market is not going to zero, which causes the shorts to run for cover and the fast money to do some buying. Then after the requisite pop higher (which will indeed take your breath away and cause some to panic on the buy side) the problems that caused the plunge will reemerge. This causes the sellers to come back to the table, thus producing a "retest" of the lows.

Now comes the important part. If - and this "if" is all-important - we see lower volume, or preferably, volume drying up during this retest of the lows, then we can be comfortable in the fact that the selling pressure has diminished. This will be an important signal that we have seen the worst in the crisis.

Have a Plan for Reentry
If you have been prudent and raised some cash into this decline, you must also have a plan to reenter the market in order to lock in the outperformance you created by managing risk. However, a common mistake investors make is to wait until they are "comfortable" before getting back into stocks. The problem is that that comfort level can be very expensive.

As we've mentioned, the good folks at Ned Davis Research tell us that, on average, roughly one-half of the gains seen during bull markets (as defined by an advance of 30% or more after 50 calendar days or a 13% rise after 155 calendar days) occur during the first one-third of new bull market cycle. Thus, if you are waiting to "feel good about things" you may miss a good portion of the move.

Our current plan for reentry, from a big-picture standpoint is as follows:
1. Wait for a lower volume retest of the lows
2. Watch for positive divergences during the retest
3. Look for a bullish breadth thrust as a signal to do some buying

Finally, it is vital to understand that jumping the gun here could be costly. I know of several market pro's who have recently declared a bottom, only to watch the market tumble -18% last week. So, it is important to avoid the game of bottom-calling.

We must recognize that the hedge fund community is in crisis mode right now due to margin calls and massive redemptions. And speaking of redemptions, don't forget that the mutual fund industry will also be bracing for huge redemptions from the public. So, this process of making a bottom is not going to be short-lived.

We don't care about making headlines here; we are only looking for an entry point that puts the odds of success (based on history) on our side.

By: David D. Moenning, Editor: The Top Gun Trader at StreetAlerts.com