Everyone that invests over a long period of time will be forced to deal with some extremely difficult market cycles. The great certainty of the market is that there will be bull and bear cycles, but every cycle plays out differently and creates a new menu of challenges and frustrations.
The current market correction is one of the more difficult that I have faced in my 25-year trading career. Why? Because it has been so well hidden by the indexes. The business media have yet to even use the phrase "bear market" although a huge number of individual stocks are already wallowing in one.
Markets like this are just the nature of the beast, but the good news is that eventually, they will create a new crop of opportunities. The most important thing of all is to protect your precious capital so that when things turn, you will be in position to profit again.
Here are five tips for navigating an ugly market.
1. Forgo the Urge to Predict
When the market pulls back and acts like it has recently, there is a strong urge to make predictions about what will happen next. There will be those that foresee a collapse and a long and brutal bear market, while others will see a fast reversal and be anxious to buy the dips.
All those folks will have compelling and logical arguments to support their predictions. They may even sound brilliant, and because we are already feeling emotional and confused after being beaten up by poor action, we will feel the urge to agree with them. We will want to make the "big call" and implement some aggressive strategy.
The truth is that no one knows how things will progress. We don't know where the market will be six months from now or how it will get there. After the bubble burst in 2000, very few folks thought that the bear market would drag out for years. Many folks were wiped out as they held on tightly to stocks in endless downtrends.
In 2008-2009, the bottom came quickly. There was nothing notable about the market turn, and the lows were never retested yet.
At the pandemic bottom in 2020, many folks never trusted the bounce that started in March 2020, but it was a V-shaped recovery, and many ended up chasing the market after months of positive action.
Just take it one day at a time. Don't be sucked into the prediction game. Manage your individual stocks and protect your capital. Be skeptical of bounces, and don't be too negative when there is more weakness. Let it play out. Eventually, the character of the action will shift, and you can put capital to work. A new uptrend will last months, and you won't miss out if you stay reactive.
2. Operate From a Position of Strength
When we don't feel like we are in control of a situation, we tend to make poor decisions. The default position when we are uncertain and confused is to do nothing. Inertia sets in, and we tell ourselves it is too late to act.
Your mental attitude about a market will largely be a function of how much cash you are holding and how much control you feel you have over the situation. You aren't as inclined to make poor decisions or suffer from inertia when you feel empowered.
In a poor market, you must have cash, and you have to be able to sell and stay flexible. That is what gives you power. It allows you to jump back in when you think the time is right, and it allows you to exit if your timing is wrong. The bear market can be easily tamed if you operate from a position of power.
3. Don't Focus on Trying to Predict the Absolute Bottom
During a bear market, there is usually a strong urge to predict the exact moment that the market has hit bottom and will start to trend higher again. That is the issue that everyone is focused on, and it creates a tendency to act too early.
You can't call a bottom after the fact. You can only do it prospectively. What happens is that the bottom callers are always early, and then they create another wave of selling when they are trapped.
Quite often, the folks that are predicting more downside are the same ones that are trying the hardest to call a bottom and buy at the exact lows. They want to be the hero that has perfect timing, and they try too hard to do so.
From a strategic standpoint, it is often better to be late than early to a market turn. Yes, you will miss out on some early gains, but if you want strength, then there will be natural support levels that will help reduce risk.
It can be an entertaining and challenging game to try to guess market bottoms on a daily basis, but it is also the easiest way to put too much money at risk too quickly.
4. If You're Going to Buy an Ugly Market, Do So Very Slowly and Incrementally
The most common way that traders suffer catastrophic losses is by averaging into a downtrend too big and too fast and then panicking, selling, or being surprised by bad news. In an ugly market, strong fundamentals or attractive valuations will not protect you. Stocks are sold without regard to their individual merits and can sink much further than seems reasonable or logical.
If you can't resist the bargains that are forming, then go ahead and make some small buys but don't keep adding into weakness, and don't let the position grow too big, too fast. If the stock is not working, then reduce it and try again later when market conditions shift.
It can help you be much more aggressive when the time is right if you do have some positions already in place, but only if you still have substantial buying power and are able to be more aggressive.
Move slowly and incrementally and wait for strength.
5. Keep Watching for New Leadership to Emerge
Every market cycle will produce a new crop of leadership. It typically will be different names than led the last cycle. The big gains in a new bull market cycle come from identifying the emerging leaders at an early point and aggressively trading them as the cycle develops.
Identifying these stocks requires vigilance and an understanding of the macro-environment, but these new leaders will attract institutional investors and will have surprisingly strong momentum as a bull market gains steam. Let the price action lead you to these stocks. They will become readily apparent as conditions develop.
An ugly market in which we are losing money makes it much harder to put forth the necessary effort to deal with it effectively. We are worn out emotionally and are inclined to just run away from it and do nothing. However, it is the bear cycles that create the great opportunities, and if we deal with them well, the profits in the bull phase will be substantial.