With the last three days shedding over 3% on the NASDAQ and over 2% on the S&P 500 it can be easy to face uncertainty over what the proper action to take should be. It is in times like this where discipline needs to take over and a well conformed strategy shines.
Most investors feel the last three days present another great buying opportunity as this is simply “just another pullback”. Other investors are more bearish noting that long term trendline support has failed and the 50 day moving averages are up next to fall victim to further sell pressure.
Regardless of your viewpoint, a disciplined strategy can serve as cruise control for decision making. Personally I was knocked back to 100% cash within the first hour of trading on 2/22 (Tuesday) which has served me well now as I simply watch from the sidelines. A gameplan is critical to long term successful investing.
Overall for those investors that may trade casually and do not have a defined set of trading rules, here are some tips to lower risk and keep the worst enemy, the mind, at bay:
1. Take some profits off the table – If holding unrealized gains from the past several months or longer, selling 25-50% of a position and locking in profits is never a bad choice. It lowers net exposure and raises cash for the portfolio.
2. Get off margin – Nothing is worse than losing money then having it being compounded by margin. Read my 9 tips for successful margin trading.
3. Don’t take any new positions – Why risk fresh capital in an uncertain market? There is no reason to, so simply put on the breaks and stop buying shares.
4. Never cost average down – I am a firm believer that cost-averaging down is a terrible idea and can end in ruin. If you are a follower of CANSLIM the adage is to “buy high and sell higher”. Don’t fall for the psychological torture of, “I’ll buy more because it is going to come back.” Wait for a fresh base or technical setup to emerge before increasing any position size.
5. Place stops and/or raise the stops already in place - Stop loss orders can serve as great insurance against the downside when used properly. They remove the psychological battle of deciding when the right time to sell is and help maintain a disciplined approach to the market. And, when the edge of a never ending uptrend is possibly over, raising current stops can ensure no significant losses are realized if the market continues to sell off.
6. Hedge downside risk with short ETFs and Options – While slightly more advanced, another way to lower risk is to buy inverse etfs which go up when the stock market goes down. This is effectively shorting stocks which can lower risk as unrealized gains are achieved while the rest of a “long” portfolio is losing value. Note though Double and Triple (2x, 3x) ETFs should never be held long term, only day traded. Also writing covered calls can be a great way to hedge. Read all options trading education articles.
7. Let your strategy lead the way – Now is not the time to lose focus and change strategies. Stick to what is most comfortable and let the rules be the guide.
One of the best lessons/reminders I had over the last few years was #7. Through the first 6 months of 2008 I found that my portfolio kept getting knocked back into 100% cash as my stops would constantly be triggered on new positions. It drove me so nutty that in July 2008 I decided to stop taking new positions altogether and simply sit back and wait for a better market environment. It ended up being the best investment decision I ever made as the rest of 2008 was one of the worst on record, ever.
While this market may very well rally back to fresh highs and surpass 2007 levels, these tips can be applied to calm market uncertainty. The best investors let disciplined strategies lead the way and navigate them through the ups and the downs. This is the primary key to success.