While most investors were scared in 2010, my True Wealth newsletter readers made a lot of money…

For the second half of 2010, most investors were scared of the economy and avoided the stock market.

But in True Wealth, we stepped up and bought. We took as much risk as we ever have in the newsletter. We bought riskier “leveraged” funds, including ROM, a double-long tech fund, and SOXL, a triple-long semiconductor fund. Buying funds like these increases your risk… but magnifies your gains if you’re right.

[ad#Google Adsense]It was the right call. Those funds soared. And we did the right thing, buying when everyone was scared.

Today, I see the opposite situation

Investors are more complacent than they’ve been in many years (as measured by the Volatility Index – the “VIX”). The last time they were this complacent was July 2007… Afterward, stocks proceeded to have their worst crash since the Great Depression. They lost over half their value before bottoming in March 2009.

But complacency itself doesn’t cause a crash. Stocks can continue to move higher as investors are complacent.

It’s more of a sign of a top when the “dumb money” is piling into stocks – when the dumb money is optimistic. Here’s how my friend Jason Goepfert (of SentimenTrader) puts it:

The Dumb Money is usually right during the trend, but when the dumb money gets extreme, the market consistently turns [down].

History suggests that when these traders are confident, we should be very, very worried that the market is about to decline. In practice, our Confidence Indexes rarely get below 30% or above 70%. Usually, they stay between 40% and 60%. When they move outside of those bands, it’s time to pay attention!

Right now, the dumb money is at an extreme… Jason’s Dumb Money Confidence Index is at 79% – its highest level in years…

[ad#ChinaBlankCheck]So investors are complacent (as the VIX shows). And the Dumb Money is supremely confident (as Jason’s research shows).

In short, where do I think the market goes next? The very worst case would be like what we just went through from July 2007 to March 2009. I don’t expect we’ll see that. But you should have your portfolio positioned for a flat stock market, at best, over the next two to three months.

While everyone else is optimistic, now is a better time to take some profits and reduce your risk instead of trading aggressively.

Good investing,

— Steve Sjuggerud

[ad#jack p.s.]

Source:  Daily Wealth