Regardless of how effective your trading or investment approach may be, it will always be at the whim of market conditions. No style works well all the time.
How do we deal with the problem? Do we shift our approach every time market conditions change? Do we just stick with what works and hope it starts to work again?
A good example of a trading approach that deals with shifting market conditions is the CANSLIM approach developed by William J O'Neil of Investors Business Daily. The approach looks at both fundamental and technical conditions to find good entries into fast-growing stock, but the "M" in CANSLIM stands for "Market." Market conditions determine how the approach is applied.
When the market is in a correction, then the CANSLIM approach suggests that we trade very little, and if we do take a trade, we give it very little room before we cut it.
Determining overall market conditions can be extremely difficult. The current market environment is a good example. A small group of big-cap names drives up the indices while most stocks are still stuck in bear market action.
The important point is that the CANSLIM model does not try to fight market conditions. It suggests that we stand aside and wait for better conditions to develop.
For many traders, this is extremely difficult to do. They want to make money consistently regardless of market conditions. This leads to forcing trades when they have less chance of working, but the itch for action is hard to ignore.
Traders don't want to completely reinvent themselves whenever the market shifts, but there are three main areas that can be adjusted when market conditions are shifting, and we want to find more opportunities. Let's look at them:
Time Frames. The first metric that can be adjusted in a difficult market environment is time frames. Short-term time frames offer an opportunity for small quick gains. It helps to eliminate some of the risks of the overall market, but day trading can be extremely challenging. The small losses can add up quickly, and it is easy to impair capital if you have a losing streak.
The alternative to very short-term trading is very long-term trading. Instead of looking for fast-moving stocks, the other approach is to focus on finding exceptional stocks that can be held for the very long term. This is essentially what Warren Buffett does, but for traders that want action, this method isn't very helpful.
Market sectors. Another way to deal with shifting market conditions is to shift the asset class that you are trading. We have an exceptional illustration of that right now. The place to be is in a handful of big-cap technology stocks that are leveraged to Artificial Intelligence. Even if your timing was not that precise, a shift away from everything else and into this group would beat any other style you could employ.
This is not as easy as it sounds. Most traders and investors have a bias toward either big-caps or small-caps, which trade very differently. I typically prefer to trade small-cap stocks because they have higher levels of volatility and are less efficiently priced, but in the current market, this group has been lagging very badly. No matter how good of a trader you may be, there is no way to keep pace with the big-cap AI names by trading small caps.
If you do shift to different market sectors, then be aware that you may also need to shift your trading tactics. A name like Apple (AAPL) will never trade like C3 AI, Inc. (AI) or some other smaller stock.
Tactics. A third way to shift your trading to deal with market conditions is to focus on tactics. For example, some of the best tradings in a bear market are produced by counter-trend bounces. Bounces in bear markets are often very big and very fast. If you are a position trader, these counter-trend bounces can be ugly traps, but if you shift your thinking and use a shorter-term time frame, they can offer exceptional opportunities.
There are a number of different tactical shifts that can be made in difficult markets. The most obvious is shorting, but shorting is not as simple as the inverse of trading long. It requires different time frames and money management skills. If you are going to be short, then you have a lot of hard work to do before you can consistently produce results.
The most important thing to remember when your style isn't working in a certain market is that you don't always have to trade. Often the best thing to do is step away and take a break. It can be very helpful at times to go completely into cash and then look at the market with fresh eyes without the baggage of positions that may not be acting very well.
Traders should seek to find a style that fits their personality and emotions but keep in mind that market conditions will always play a large role in how well your style works.