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That was the headline I found over at CBS Marketwatch.  As usual, the news media is whipping (anyone who will read) into a frenzy about Lehman Brothers.  More news may be forthcoming about Lehman — between the time I finish writing this and the time you read this.

I have no idea what’s going to be the final outcome for Lehman Brothers.  And further — I have no idea what impact that will have on other financial stocks, or the stock market.  But what I can tell you is many financial stocks will be reporting quarterly earnings (or write offs) shortly.

And it also happens to be option expiration week.  So, expect a great deal of volatility the next few days.

But in which direction?  Stay tuned.

It really is pretty amazing to see names like Lehman Brothers and AIG being discussed in the media as possible wipeouts.  This really could be the end of an era, or a changing of the guard.

Additionally, the primary indicators I use to determine whether the market is on offense or defense (the bullish percent index) has just signaled a change (this week) from offense to defense.

By definition, this index measures the percentage of stocks in a group which have a bullish pattern.  If the number of stocks with bullish patterns shrinks, the market cannot possibly go up.  Essentially, fewer and fewer stocks are rising — the tide is moving out.

Over the years, we have seen periods of defense where the market has done nothing, or gone down slightly.  But there have also been times in recent years where the market has dropped a fast 6% to 8%.  And that kind of move can be accomplished in a matter of days — not weeks.  6% of the current Dow Jones Industrial Average (11,421) is 685 points.

We have seen several 300-point swings in a single day this year.

Moving from offense to defense does not necessarily mean that the market will go straight down.  What it tells us is that the risk of losing money is greater today than it has been in the recent past.  The average period of time the market stays on defense is a little more than 60 days… some periods are longer, some periods are shorter.  Just keep in mind that if you buy stocks when the market is on defense it’s like trying to swim upstream — it’s a tougher direction to go…but it’s not impossible.

What should we normally do when the market flips from offense to defense?  In general, we should remove any investments that have poor relative strength, or poor technical attributes.  Essentially, weak stocks will fall apart.  They should be the first to go.

This is what we need to focus on right now.  But remember, moving to defense does not mean “panic.”

Another good practice at this stage of the game is to review stop orders.  It’s a good idea to have stops underneath stocks that were purchased recently.  If you don’t know where stops are (or should be), call me.

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