Tuesday, September 30, 2008

Trading in the Bear Market

If I was in a position to give an advise to an individual investor (commonly known in the modern investment world as a "BagHolder") - the only one advise would be: "DO NOT TRADE"

That being said, let me explain "Why"

In a true bear market commonly used approaches, no matter "fundamental" or "technical" mostly lose reliability, not even speaking of "duration".

Any fundamental analysis are based on "historical data and expectation of continued performance" and bear market changes everything - what hope investors had based on "past performance" guaranteed even less in the bear market than in bull cycle.

So, this post is addressed to "Traders", to the people who have total respect for risk control, who are flexible, nimble, and totally lack desire to be right as oppose to "make money or at least preserve capital".

Let's make a list of "dos and don'ts"

  • Decrease your trading account size. Some first recommend to cut down trade/position size, which is the right advise as well, but by cutting your account size and putting money in "not so easy to access safer place" we will fight natural human tendency to "look for a bargain and use money we decided to keep in cash".
  • Decrease your trade size. Moves in true Bear Market are sudden and violent - don't think of "bigger profits", be afraid of "bigger losses"
  • Decrease the number of simultaneous positions. If in "easier" market you would normally have 20 positions (and this is the total of ALL positions in ALL accounts, not even "total of different securities") - cut that number in half - pressure WILL mess you up sooner or later and your stops will fire more often resulting in more frequent losses and shakeouts.
  • Take your losses and profits faster. In the true bear market there is no trend, not even down, there are "moves". At least scale out of winning trades - today's trades might turn into tomorrow's losers in the blink of an eye.
  • Don't rush back in, pick your "spots" - retail trader has very few advantages over institutional traders and the main one is "We DON'T HAVE to trade" (If you HAVE to trade - that means you started trading inadequately capitalized and you WILL lose your money)
  • Employ OPTION - use options to hedge, use options to bet smaller amount of money for controlled risk and greater reward. Do NOT sell naked options!
  • Trade reversals. Forget about common saying "It is very expensive to try to pick tops and bottoms". You really have better chances ( if you understand what to look for) to make profits faster on reversals. You can buy/cover cheaper and sell/short higher. But you have to have "balls of steel" for that type of trading and be ready to cut bad trade short as soon as your original "point of view" proves to be wrong.
  • Do not pile up your trades - if you losing on 2 positions you will lose 20 times more money on 10.
  • Absolutely DO NOT read blogs of people who can not demonstrate that they capable of trading in bear market. Try not to read at all, really, in bear market most of those who were profitable in bull market ( and thought of themselves as "good traders") are losing money. Beside, even if they right - you might be late to the table and you are not capable of seeing the trade from their perspective. Beside, the moment you start looking for "outside opinion" it signals that you losing and have to stop trading.
  • Do not watch CNBC - if you do - listen to intonations of Larry Kudlow and Dennis Kneale. When Larry getting  more hysterical and rude or Dennis getting more "contrarianly optimistic" - run for the cover - BEAR is off the leash. Remember - they are paid to make you BUY.
  • Sell/cover the "News" - you will not get the second chance.
  • Forget IBD ( Investors Business Daily) approach, even if you'll try to use it "in reverse" for shorting - you will have better luck not using it at all.
  • Pay more attention to the quality of services provided by your broker, don't look for "cheap", look for reliable - "cheap" will cost you more in losses and profits not made.