Since the market bottom in March, there has been two-tiered action. A small group of big-cap technology names that I call the FATMAAN stocks have dominated the action. They created a false impression of very broad strength, and then when the group finally corrected they covered up some stronger action in secondary stocks.
The reality is that the rally off the March lows was not nearly as robust as the indices have indicated, which changes how we deal with what is going on now. The vast majority of stocks in the market were never that extended and many of them still have some good support. Only around 20% of stocks are over their 40-day simple moving averages (SMAs) and about 36% are over their 200-day SMAs. By comparison, the Nasdaq 100 ETF, Invesco QQQ Trust (QQQ) , is still about 13% over its 200-day SMA and is much more extended than the average stock.
With this context, there are a number of considerations to keep in mind as you navigate current market conditions.
- In a market correction, stocks tend to move in a correlated manner. The main concern of market players is to avoid losses, which manifests itself by selling stocks without regard to their individual merit. It is the opposite of a stock pickers' market. The indices drive the action and that means it is important not to rush to buy stocks simply because you feel they are cheap.
- Don't focus too much on trying to predict an exact low. The goal isn't to buy stocks at their exact bottom. The goal is to buy stocks when they have the best chance of sustained upside, and that typically occurs only after there has been some bottom action first. You are not going to miss out if you are not fully invested at the exact bottom
- Work on developing good shopping lists, A market turn can occur quite abruptly and if you already know what stocks you wish to add in a better market environment then it makes it easier to move quickly and decisively.
- The stocks that lead a rebound won't necessarily be the same stocks that led the last run. Leadership is likely to shift as the corrective process takes place and there will be new themes and sectors. Don't be beholden to stocks simply because they have treated you well in the past.
- It is never too late to sell. You can always buy a stock back and if you need to pay a higher price just think of it as an insurance policy. Sometimes selling may feel wrong, but it can pay off in removing heavy emotional costs.
- Watch for failed bounces. The hallmark of a market correction is failed bounces. Downtrends are a series of lower lows. Don't be too quick to trust a bounce to mark a market bottom.
- The biggest bounces occur in the worst markets. Counter-trend trading in a correction can be very good as some of the bounces will be quite sudden and very large. The key is to make sure that you are extremely disciplined in your trading and that you don't turn a failed trade into an investment.
If you have some positions that look poor, make sure you take a hard look at them and consider reducing them just to free up some emotional capital as well as monetary capital. There will be plenty of opportunities to put cash back to work as this correction plays out.