The market has been setting records for movement in the past month as it deals with the coronavirus crisis. The moves not only are record-setting but also random and inconsistent. It is always hard to navigate the twists and turns of the market beast, but even more so in the current environment.
There is no secret formula for dealing with this sort of market, but the one thing that can help the most is managing your emotions. Managing emotions is extremely helpful, not only because it makes you less impulsive but also because it helps you consider the market more objectively.
The thing that will influence your emotional state more than anything else is the level of your market exposure. No matter how hard you try to apply cold, hard analysis to the situation, it is impossible not to let hope enter the equation to some extent if you have money on the line. If you are holding positions the only real way to remove emotion is to have a plan in place to deal with the positions as they move. Even then, there will be enormous pressure to change that plan as your emotions start to flare up.
One of the most common pieces of trading advice is to have a solid plan for your trades. Even though it isn't particularly difficult to come up with some sort of method for controlling risk, it is one of the hardest things for many people to do because they can't resist the pull of their emotions and they end up changing their plans on the fly.
The more heavily invested you are the more difficult it will be to resist the tug of emotional reactions, so it becomes even more important to have a plan in mind and then execute on it. What will happen in almost all cases is that your plan will not prove to be timed perfectly. You will question the wisdom of your strategy because the market is making you feel foolish.
The pursuit of perfection is your biggest enemy. It will make you abandon very solid plans for risk control because the market will make you feel like you are an idiot for not predicting what it will do. Be aware of this tendency and don't berate yourself for sticking to your plan even though an alternative course of action may have proved better. Rigid discipline will pay off extremely well in the long run, although it will be suboptimal in many individual cases. There is a natural tendency to focus more on the bad strategic decisions than the good one. The pain of loss is always felt more intensely than the pleasure of a gain.
If you are holding very high levels of cash, you still must manage your emotions carefully. This past week the indices had one of the biggest bounces in history and there was great temptation to jump in as "fear of missing out" started to kick in This emotion can be one of the most dangerous as it is driven in large part by celebration in the business and social media. No one wants to feel like they are missing out on a party, especially after a period of intense gloom. Some of the worst buying decisions are the impulsive ones in strong markets. If you can't resist the temptation to join in, make sure you keep the buys small.
Another emotional trap that occurs in a market like this is the great desire to make up losses quickly. We are upset that we have allowed losses to grow too big and that makes us anxious to take aggressive corrective action to fix the situation. We become emotionally inclined to over-anticipate bounces and are fast to predict a bottom because we want to start making up some ground right away.
The big pain in bear markets comes when bounces fail and there is a slow drip of selling each day. It is very common to give up in disgust as hopes of ever making up ground evaporate. The excitement of timing the bottom perfectly disappears after a number of failed attempts.
It is often said that greed and fear are the emotions that drive investors. Greed is just the fear of not making enough money, so at the heart of it all it is fear that controls what we do. The best way to deal with fear is to embrace it and try to understand it. What is it that you fear? That you are holding too many stocks and the market won't stop going down? That you have too much cash and won't be able to put it to work?
Make sure to separate out the regrets of the past. You can't change what has already happened. You can only control what you can do now, and if you understand your fears then you will be able to make some plans. Simply sticking with those plans will help you more than anything else, but you must keep in mind that there will be constant internal pressure to change them.
Patience is the best antidote to making emotional decisions. There is a tendency to develop strategies like buying weakness or selling strength, and in the vast majority of cases we act too early rather than too late. We want to move immediately when we formulate a plan rather than wait for conditions to improve. The best way to deal with this is to move incremental and to buy some patience by making small moves initially.
The most important emotion to cultivate is optimism. Not optimism that the market is going to go straight up, but optimism that you will always be able to find great opportunities regardless of market conditions. I know that if I keep working at this job of trading I will be rewarded even if there are some short-term setbacks.