When the market is chugging along in a steady uptrend we don't give much thought to our trading style. We just keep doing what works and act as if it will continue to work. However, eventually there comes a time when the character of the market shifts. Suddenly the old approach is producing losses, not gains. But instead adapting we often just stick to what we know best.
Over the last several months we had a particularly good example of how the best approach to playing the market can undergo a dramatic change. For much of the last six years the style that worked best was buy-and-hold and trend following. The market only moved in one direction for much of that time and you simply had to stay with it in order to make money.
But as talk increased about the potential for interest-rate hikes, the market began to stumble. Suddenly all those top callers that had been doing so poorly started to make some money. The style that had been out of favor for so long was suddenly the best approach.
Many traders are very dedicated to a particular market approach and will not change when the market does. They simply refuse to shift because they aren't comfortable with a different way of thinking. As long as they are willing to stand aside when the market goes through a transition it doesn't matter, but if you want to stay active in a variety of circumstances it is very important to be aware of different approaches.
Once you have clarity on various options you can focus on developing them to deal with different market conditions.
There are two broad categories of trading: anticipatory and reactive. Anticipatory traders focus on calling turns in the market and individual stocks. They tend to short strength and buy weakness. Real Money Pro's Doug Kass is a good example of this sort of trader.
Anticipatory traders try to catch trends as they develop. The thinking is that it takes a while for the market to fully appreciate news. It is not priced in immediately. Analysts tend to raise estimates incrementally, and buyers tend to be slow to react, doing so when they fear being left out.
Reactive traders tend to buy strength and sell weakness.
Since mid-August we've had a market that tended to favor the anticipatory approach. "Buy the dips and sell the rips" worked very well as we constantly changed direction.
However, there always comes a point when the trading range action comes to an end and a new trend develops. That happened this past week when the confident bears that were doing so well selling every spike higher were trapped when the overbought market became more overbought.
Bottom-fishing is a form of anticipatory trading that has attracted a lot of attention recently. First, we had the massive breakdown in oil and commodities that seemed to go on forever. More recently, we have seen a massive breakdown in biotechnology and health care stocks.
There have been a surprising number of very large drops on bad news, such as Valeant Pharmaceuticals (VRX) and Community Health Systems (CYH). For some traders these panic selloffs are ideal for trading. They are high reward, but also very high risk as there is often more bad news lurking.
The key to finding a style is to be very aware of your thought process. Some are drawn to buying only those stocks that are attracting the most positive attention. They want to be in the "best" names. Other folks hate the idea of buying anything at its highs. They want bargains and gravitate toward buying names that are down substantially.
Neither approach is inherently superior. Good bottom fishers will do very well in the right markets and good momentum traders will also do very well under the right conditions.
The hardest thing is being able to adjust as the market shifts. Not many people can do that easily as it requires a major shift in thinking. If you are self-aware you have a better chance of making this sort of transition but it requires that you actively acknowledge that conditions have shifted and a different style is needed.
The market goes through constant changes, which means that to be a great trader you have to evolve and adapt. Simply being aware of that process is half the battle.