Don't Let the Market Bring You Down
Rather than looking to be a participant in what will surely be some exciting action, consider settling in for a front row seat and choose to be a spectator.
We always face a conundrum when the market spirals out of control, assuming one has already heeded prior advice and taken appropriate steps to raise extreme levels of cash. The draw of re-entering the fray becomes increasingly attractive and the challenge lies in when to start wading back in. As we sit back and watch, we start to see incredible bargains develop before our eyes and we begin to realize that fear and panic have now taken over, as emotional traders throw out inventory at any price. Higher momentum growth stories, the stocks that I typically favor, see bids disappear, sending the stock plummeting 30, 40 or even 50% off recent highs. We desire to wade back in and nibble here and there, however, at the same time, the prevailing desire of keeping all limbs intact remains strong, which is obviously a good thing.
Days turn into weeks and while our patience has proven to be the best course of action, we start to wonder if we shouldn't dip a toe in, while the blood is running and some of our favorites look incredibly attractive. While I think the thought process is very constructive, I believe there are a few things to keep in mind should you be thinking along the same lines I am.
1) A New Trend. At this present time, all major averages have broken through short and mid-term up-trends raising the possibility of the markets entering a prolonged downtrend. One of the most basic and foundational rules of trading is to always have the wind at your back. While we may be thinking longs look attractive, it may be that the market is going to enter a prolonged downtrend demanding we shift our focus on playing the short side. The point is, we must remain open-minded either way.
2) Moves always last longer than we believe is possible. This is true both on the upside and downside, and is worth noting and keeping close by. I have fallen victim myself, and seen traders time and again close out a position when they believe a run is over, just to see the stock continue to move much farther, at the same time, wading into a stock when they think it has gone down too far, just to see if plummet more. Stepping in to catch a falling safe is never a good idea, and should the market find its footing and look to resume its uptrend, individual stocks will confirm this with prudent and constructive setups, offering us appealing entries with excellent potential. Rather than looking to nibble at falling prices, wait patiently for prudent setups to develop.
3) Be Prepared. During a draw such as the one we are having, you will often hear me state time and again to "update your list." This is not just a passing thought: this is a very real and constructive way to spend your time when others are panicking and in a zombie-like state watching every tick. Start to re-evaluate stocks you owned prior to the drop, dig a bit more into their stories and financials. Look at other high growth names that everyone wanted when the market was acting well, and add them to your list. Should the market resume its uptrend, you will want to be prepared with a full list of opportunities you desire to play without the need to scramble for new ideas.
4) Reduce your Purchase Amount. If the allure is too great and you feel you must nibble a favorite name here or there, take what would normally be a full position to you, and divide that by five. This, in my opinion, should be what is an appropriate size to start with. For example, if a normal position in stock XYZ for you would be 500 shares, you will start out with 100, if your desired position is 100 shares, rather than buy 20, you may just want to take a pass. The reason behind this is because more often than not, you will not catch a precise bottom and you will only see the stock move further. I have often found as well, that a stock offers a better entry, once it has stopped going down, and resumed at least a shorter term uptrend. Therefore, keeping your capital in tact and playing with only a small amount will curb the anxiety of wanting back in, at the same time as limit the potential damage, should you be wrong.
5) Preserve Capital. I believe that during a draw down, people's attitudes change from initially wanting to preserve capital, to one of wanting to be a hero and jumping back in before the rest of the crowd. The thought is that if we can catch the turn exactly, not only will we make oodles of money, but we will look incredibly smart to those we know who we informed about such plan. In my experience, if you are looking to end your trading career this is a good strategy to have, however if you desire to be in this game for the long haul, a slow and steady climb always beats a hero's approach and therefore, preservation of capital should remain our first and foremost goal. Unless this is the one time all markets go straight to zero, this too shall pass and those left standing will be able to participate and do quite well. Being successful in the market, is not about catching turns, it is about preserving capital during the draws, and waiting until the environment is right to wade back in.
We are sure to see some fireworks this week either which way as all eyes will be on Tuesday's Fed meeting and Cisco (CSCO) earnings. While the allure is great, individual traders have no edge in playing these movements and rather than trying to catch a bounce or press another leg lower, should wait patiently in extreme levels of cash, until the prevailing trend develops. At this time, the individual can ride the institutional wave and let others do the heavy lifting. Rather than looking to be a participant in what will surely be some exciting action, consider settling in for a front row seat and choose to be a spectator. It is much safer that way and you will definitely keep all your limbs intact.
Futures are bouncing this morning with oil trading slightly lower. It looks as if some are second-guessing their panic selling into Friday's bell. We have plenty of events on tap this week to keep us on our toes, and I still see no edge in attempting to game it either way.
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