“It was the best of times. It was the worst of times. It was the age of wisdom. It was the age of foolishness.” A Tale of Two Cities by Charles Dickens
As I write this the “Market” is down again. In actuality there are many ‘markets’ within “The Market”.
And, you are hearing statements from every business channel and pod-caster that “The Market” is moving from a Bull to a Bear.
It may help to think of it like this: The Dow Jones stocks are a market. The stocks in the S&P 500 and the Nasdaq are markets. The Russell 2000 can be considered a market.
I heard an analyst say this morning that (paraphrasing) ‘the Nasdaq does best in a Bull market and worse in a Bear market because of its higher risk. The Dow stocks will pull through a Bear market better because they are the biggest, strongest companies with much less risk’.
What are Bull and Bear Markets?
A Bull Market is characterized by optimism and confidence in current and future economic conditions. There is significant demand for stocks and a steady rise in share prices across the broad market.
The Bear Market, by contrast, is characterized by poor investor confidence, significant concern about the economy and market risk. A decline of 20% or more over several months indicates a Bear Market. This may include all of the Exchanges or only one. For example, you may hear an analyst say “the NASDAQ is in Bear Market territory”.
In essence, a Bull Market indicates steadily rising stock prices over a period of time and a Bear Market indicates the opposite.
As investors, we could think of each Sector as a separate market, comprised of stocks cutting across all 3 of the major Exchanges (markets).
And given that, there are opportunities whether The Market is a Bull or a Bear!
However, just not right now, for the average investor who follows the dictum – ” Rule # 1 Never lose money.” – Warren Buffett.
Systemic vs. Non-Systemic Downturns
Just the other day someone asked me what can you do when the market is going down like this?
Downturns are generally classified as either a Non-Systemic or a Systemic downturn.
A Non-Systemic downturn typically refers to a downturn that impacts a single industry or sector.
While a Systemic downturn typically refers to a downturn that impacts the entire Market and is far more serious.
When faced with a Systemic downturn most investors have few options. The best option for most investors is to sell at the first signs of a Systemic downturn.
Unfortunately, it is very difficult to foresee the early signs of a Systemic downturn. And it is impossible to know, in advance, the depth and duration of a Systemic downturn.
The last two Systemic downturns of 2008 and 2020, came on quickly and caught many people by surprise.
The downturn of the year 2000 was persistent and took 3 years before it hit bottom. During those three years there were several periods where it appeared that the market had started to recover, only to turn down again. In took several more years to fully recover.
And so, if you miss the early signs of a Systemic downturn, it’s very difficult, emotionally, to consider selling after you’ve already absorbed what you consider a big loss.
The challenge is what’s BIG? The value of a portfolio dropping 20% feels big, until that portfolio drops 40%.
We know the feeling. We did it twice in 2000 and 2008. The nicest way to put it is, it was very painful.
Short of selling, the average DIY investor is unlikely to be skilled enough to begin using some form of hedging techniques.
A Best Practice
A practice we learned from studying the Trend Following strategy, which we now employ, and always stress to our members, is the use of Stop Loss transactions.
The Stop Loss Order will not eliminate all losses, but it can limit the size of your loss, hopefully, to a number that you can live with.
I personally always use Trailing Stop Loss Orders.
Today the last stock in my portfolio reached the Stop Loss and the order was executed. As a result, I am completely out of the Market. I did take a haircut on that one, but a very small one.
Now I’m sitting on the sidelines in cash and ready to take advantage of some good buying opportunities when the market begins to turn.
That sounds easy, but it’s not. You must have discipline. The discipline is having the patience to wait until the market really demonstrates that it has turned.
According to Warren Buffett, “The most important quality of an investor is temperament….”
There is nothing wrong with sitting on the sidelines. There is an old saying “fools rush in where wise men fear to tread’.
If you are fortunate enough to be sitting on the sidelines with most of your money, be thankful and be the “wise” man or woman in the group.
The two questions that always follow that explanation are:
1. How do you know when the market has turned Bullish?
The short answer is: you don’t really KNOW.
As with many things in life, you don’t really know, but you can use some facts to move things in your favor.
An indicator is if the market, i.e., the S&P 500, has turned and moved up 10% to 15% from its low.
That should give you some confidence that the best performing stocks in the S&P 500 are actually performing better than 10% or 15% and therefore they are candidates for your new investments.
This also applies to your favorite ETF which represents a bundle of stocks.
As the Market turns and starts to improve, you’ll typically find that a small handful of the stocks in that bundle are actually driving the growth.
You may be better served considering an investment in those individual stocks versus investing in the entire ETF bundle. Or do both and allocate some funds to each.
Some people want to jump in sooner.
However, since we have lived through several false recoveries, and listen to the guidance of trend following experts like Jerry Parker, CEO of Chesapeake Capital Corporation, we stay patient.
When you buy a stock, use the Trending Stocks Trade Risk Calculator© to help you determine the number of shares to buy to stay within your personal risk tolerance.
And place a Trailing Stop Loss Order found on the Today’s Results report for that stock. As the stock’s price moves up the Trailing Stop Loss will continue to reduce your risk and eventually none of your original investment is at risk.
A common problem investors face is at what price to place the Stop Loss Order.
Fortunately, Trending Stocks calculates a Stop Loss based on the volatility for every stock and ETF listed on the major US exchanges at the end of every trading day.
The Stop Loss may eventually take you out at some point, but hopefully at a point where you have locked in gains and minimized losses.
2. Isn’t there something you can do in the meantime?
Here again the short answer is YES.
While the Market is bouncing around and you are on the sidelines waiting, is the perfect time to prepare! It can be a golden opportunity.
Even when the market takes a large downturn there are almost always some companies that either change their spots to take advantage of the current situation, or the current situation just happens to work in their favor.
A good set of recent examples can be seen in the downturn of 2020. Almost every company was negatively impacted by Covid and the downturn in the market. Airlines, hotels, restaurants, theaters, sporting venues, and many others suffered economic hardships.
Yet the circumstances that arose created an opportunity for companies like: Zoom, Netflix, Disney, Amazon, FedEx, UPS and more.
Currently, all signs are pointing to a further downturn in The Market, perhaps another 20% or more, and even warnings of a coming Recession.
This may be a good time to take a look at the Sectors and the stocks within them, that are excelling .
One of our members likes to look ‘up the chain’ for investment opportunities. She loves her electric car and knows electric vehicles need about six times the amount of minerals compared to conventional cars.
This includes things like copper, manganese, lithium, cobalt, nickel, graphite, etc. Rather than invest in the companies making the cars, she invests in companies providing these critical materials and are trending.
What products or services do you really like?
Think about the ‘up chain’ possibilities and be sure to put those stocks in your Trending Stocks Watch List. We will track them and notify you when they start trending.
And finally, remember, you are not planning to be invested in any single stock forever. Only long enough to take advantage of the growth. “Marry a spouse not a stock.”
If you’re not prepared to accept the risk associated with being in the Market right now, that is also a good choice!
Continue to use the Top 25 Stocks and ETFs, as well as the Detailed Search Screener, for information on stocks coming out of the downturn and don’t invest until you are really ready.
One way to know that things are improving and it may be time to reenter the market is to watch the Trending Stocks Dashboard which will indicate the Market Condition as “Good”.
Have questions? Reply to this email or send a question to firstname.lastname@example.org . We love answering questions!
Our goal is to help all investors grow wealth and manage risk to keep it!
To that end, always remember: Ride Your Winner; Cut Your Losses!