Here are a few key points to address for those who are asking this question of themselves right now. Many have been caught off guard by the sharp selloff in stocks across the board, and this is a concern that they have right now. The short answer is that there is no short answer, but I will try to keep it simple.
A brief conversation with a family member who called me over a week ago, and was very upset over her self-directed 401K account, went something like this:
She asked me, “What should I do? What’s happening in the markets?” I go out of my way not to give advice, because it is usually a no-win situation, and I am not a financial planner, but I am very good at asking the ‘tough questions’ and let people figure it out on their own.
I asked: “If your account dropped another 20 or 30% how would you feel?”
She responded as expected, not acceptable.
I then asked “If you go to cash and the market rallies 20% and you miss out, how would you feel?”
She said, not good.
I then asked, “Assume you get it wrong, which way would you rather be wrong, wrong with cash or wrong and down 20% more”?
She replied “What do you think I should do?”
My response was: “I can’t make that call, you have to”.
She decided to go half into cash, that’s what worked for her. Everyone is different.
As a full-time trader, we are accustomed to talking about things like stop losses, position sizing and risk management all day, every day. For the average investor, who has a busy life and daily concerns of their own, these things don’t usually come up until markets hit a sharp downswing, as we have had recently.
Everyone has to operate at their own comfort level. I have learned over the years that by asking myself the “which way would I rather be wrong” question, it helps me make a better decision.
“DON’T SELL DOWN HERE”…
This is something that I have seen posted online alot over the last few weeks as the S&P has dropped from 3393, to 3200, to 3000, to 2800, all the way down to 2300. For those of us who use stop losses and price exits, this is never a concern, as the stops let the market take the positions out. There is no decision to make, it is rules based. For those who do this casually, legendary trader Jesse Livermore talks about ‘selling down to the sleeping point‘. This essentially means to reduce risk down to the point where it is at a comfortable level.
Many who heard “don’t sell down here” at $SPX 3000 and 2800 wish they would have sold now with $SPX at 2300.
Nobody ever knows where the bottom is or where the top is. Some claim to have ‘called it’ , but they have also been ‘calling it’ for years and finally got one right.
Nobody knows where the low will come in, at 2300, 2100, or lower, every market is unique and noone can predict the future consistently.
I use scale in/scale out as opposed to all in or all out (all at once). I raised cash from 20% to 90% over a three week period and had zero equity exposure going into this last week, where the S&P was -14.98% on the week. Stops went off starting in late February, and as the stops hit, I let the cash build. I want to buy things on the way up, not on the way down.
For some, reducing some exposure works best, for others, they want to wait it out. Everyone is different, and for some, reducing any exposure takes the pressure off. If markets go back up, they participate on the upside, if markets head lower, they have reduced exposure.
BEWARE OF TRYING TO OVERTRADE YOUR LOSSES BACK
In my early days of trading, I tried to recoup losses right away by taking an immediate position, often bigger to ‘get my money back’. This usually backfired on me, and I dug myself into a bigger hole. What I have learned to do over the years, is as soon as my equity starts dropping or I have a series of stops go off, is that I trade less, not more, and I look for stability vs ‘getting my money back’. If I am out of tune with the market, I wait until I get back into the flow of the tape.
I equate this to driving on an icy highway. A few years ago, I was driving my all-wheel drive SUV on an icy highway, hit a patch of ice, and could feel my back end start to slide with no traction, at 50mph. I had three choices:
1/ Step on the gas
2/ Slam on the brakes
3/ Do nothing and let it work it’s way out
I did #3, and we caught traction quickly. Most traders, my past self included, take option #1, trade more or bigger, to get their money back. The results are usually the same as stepping on the gas on an icy highway. Think about it for a minute.
DOING TOO MUCH
Some will look to go short to get their losses back, which could work, or they could find out that bear market rallies are the sharpest, and often reverse their shorts out at a loss, just in time for the next leg down to start. I have found that usually ‘doing more’ leads to more complication.
I have traded long and short at the same time, and for me, it added complication. For me, higher cash is the best hedge. Option 2, if I had to, would be just to buy straight index puts, or index ETF puts, not as a directional trade, but as some type of buffer to try to mitigate any further downside. I am not an options expert, so I simply look at the largest open interest position for my time frame, and go on the premise that options experts are gathering there for a reason.
In summary, there is no easy answer and everyone has to make their own decisions. Managing risk is based on each individuals time frame, objectives and risk tolerance.
I don’t try to call market tops or bottoms, but I do use a few price signals to let me know when a change of trend is at hand.