The easiest way to know that the market is undergoing a correction is to count the number of times you hear the phrase "buying opportunity" in the business media. Market pundits and fund managers love to tell us that we should hurry up and buy when there is market weakness. They warn us that if we don't hurry and put our money to work, those great bargains will suddenly disappear.
Most of the people dispensing advice in the business media have a vested interested in making sure you stay invested. If you have cash, there is the risk you may walk away from the market -- and that isn't good for money managers and market pundits. Being correct is always secondary to making sure you stick around.
Sometimes the "experts" are correct and the pullbacks are buying opportunities. In recent years, corrections have been shallow and short lived. Those that were quick to buy weakness generally did quite well, but when a real correction finally does occur, "buying opportunities" can be an ugly trap for the unwary.
Handling buying opportunities is one of the key determinants of trading success. Few things will produce better returns than handling pullbacks in the right way. However, mishandling buying opportunities probably wipes out more traders than anything else.
The biggest danger in bad markets is rushing into positions too big and too fast. As position size grows in a bad market, the potential for an emotional response to the stress grows. In many cases, we end up throwing in the towel when the bottom finally occurs. That is why so many folks suffered some much in 2001 and 2008-2009. They stayed with poor positions too long and finally gave up when the misery became too much.
The first step to taking advantage of buying opportunities is to make sure you have a solid list of potential candidates. It is extremely important to be familiar with the personality of a stock and to understand the risks. Is there something other than market conditions impacting the stock?
An example of one stock on my shopping list is The Trade Desk (TTD) . TTD provides a platform for buying internet advertising. It had a very strong April quarter, but hasn't done anything since then. It has great growth and is fairly expensive, but the valuation doesn't look bad. The company is not likely to be that economically sensitive, so I view it as attractive to buy on further pullbacks. In a weak market, it is very likely to sink with technology stocks.
Once you identify your "buying opportunity" stocks, you must develop a plan.The easiest mistake is to buy into the teeth of a decline too fast.The goal isn't to buy the bottom tick, but to buy when there is the best chance of sustained upside.
I currently have a small position in TTD, but I'm not interested in adding right now -- although it is sitting at some technical support. I'll consider a buy if it breaks support or if that support holds and the stock moves back up toward resistance levels.
The power of the "buying opportunity" trade comes from moving incrementally. You have to have a plan for your ultimate position size and then work out how you will reach it. There is nothing inherently bad about averaging down, although some traders would disagree, if it is part of a plan. I find that if I keep my buying very small when there is downside pressure and then increase it as a turn starts to occur, I can avoid the "catching a falling knife" issue.
It can be amusing when you notice how often the words "buying opportunity" are used by experts, but if you focus on finding good candidates, making a plan and being patient, they can work well. Just make sure you act strategically and not emotionally.
Eat, Drink and Talk Money with Jim Cramer
Meet Jim Cramer at an exclusive reception at his Bar San Miguel in Brooklyn, N.Y., on Tuesday, July 25, from 6:30 p.m. To 9 p.m.
The evening will start with a screening of Jim's CNBC show Mad Money. Afterwards, Jim will join the party fresh off of the CNBC set to mingle, take photos and answer your investing questions.
Tickets include dinner, drinks and an autographed copy of Jim's book Get Rich Carefully.
Click here for more information or to buy tickets.
Where: Bar San Miguel, 307 Smith St., Brooklyn, N.Y.
When: Tuesday, July 25, 6:30 p.m. to 9 p.m.