Market conditions have undergone a substantial change since the end of January. If you have continued to trade in the same manner that you did to start the year, the likelihood is that you have not been doing very well recently. There are still opportunities, but they are now quite different than what they were.
Good traders tend to have very clear styles and some rigid rules, but they also know that the market requires constant adaption if they wish to maintain an edge. What works well in one market, may be a disaster in another.
Here are five important factors to consider when dealing with changing market conditions:
1. Remember the Pareto principle which is also known as the 80/20 rule. For most endeavors about 80% of your results will come from 20% of your efforts. For traders this means that you can expect about 80% of your profits to come in about 20% of your trading days. The remaining 80% of your time will be spent making little progress.
If you understand and embrace this principle it can save you much frustration. There are going to be many times when you will not make much progress at all. That doesn't mean that your trading is flawed. It is simply the nature of the market beast. When it becomes more difficult to make progress the answer isn't to push harder but to be better prepared for when the 20% of the time comes that will produce your best results.
One thing that prevents me from becoming negative in a poor market is that I know that it is just a matter of time before the good times will return. The cycle is inevitable and requires that we stay positive and patient while we wait.
2. Down-trending markets are not just the inverse of up-trending markets. You can't simply reverse what works in a bull market to make progress in a bear market. One of the big differences is that downside moves tend to occur much more abruptly and to be more sizable. There is an old saying the market takes the escalator up and the elevator down.
This tendency means that you must be fast and aggressive to play defense. If you don't cut losers quickly you will end up with a lot of languishing stocks that inhibit your flexibility as well as your mindset.
If you short stocks you can't handle them the same way you handle longs. Typically, time frames will be shorter and you will need to be more anticipatory.
3. Trade counter to the trend. You don't have to short to make money in a bad market. Down-trending markets often offer some of the best countertrend trading. The biggest bounces almost always occur in poor markets. This boomerang effect when things become stretched to the downside can offer great opportunity if you time it right. We saw a good example this past week when the DJIA bounced nearly a 1000 points after the China trade war news.
While these countertrend moves can be huge they can be very difficult to time. You must be ready to move quickly when they start to develop. That means having a list of trading vehicles ready and having a trading plan in place. If you know you are going to buy Action Alerts PLUS holding Facebook (FB) or an index ETF when the conditions are ready, you will be able to move 10x faster than those that are still trying to figure out what is going on.
4. Don't reinvent the wheel but adapt your style. If you are a momentum trader that tends to buy strength and new highs, you will have a hard time dealing with a market that is struggling or in a downtrend. Many momentum players simply raise high levels of cash and move to the sidelines. That is understandable but if you are willing to make changes to your standard style you can still find many opportunities.
I tend to favor momentum, but I find in the current market that there are good opportunities to slowly build positions in stocks that are drifting lower. I don't want to see them fall into full downtrends, but I try to use support levels carefully and to use very wide scales for building positions. The goal is to catch them as they find support and turn back up. It's a different game than momentum and requires different thinking but it can offer great potential.
5. Shift your time frames. In an up-trending market, you can afford to be more patient with stocks that are not working. A rising tide will lift all boats but when things turn down there should be far less tolerance for stocks that don't do what you want them to do. Also, good trades tend to fade fast in a poor market. Don't let those gains slip away.
When market conditions turn poor many market players turn into long-term investors rather than short term traders. They hold on to stocks that aren't doing anything as they wish and hope and pray they will bounce back. They forego the quick profits that come from countertrend moves and stay tied to the longer-term stuff that is quite in the down cycle.
Poor market conditions require shorter term time frames unless you have a very specific play to hold a stock as a long-term investment. Don't let trades turn into investments.
Poor markets shouldn't be feared. They should be embraced as a source of new opportunities. All that is required is that you change the way you think about them.
-- This article was originally published on April 7.