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This proved true again as all major indexes flopped in the last two weeks.
Our TradeSmith Finance Market Health Indicators categorized each of the major indexes as follows:
- Nasdaq 100 (NDX) — Yellow
- S&P 500 (SPX) — Green
- Dow Jones Industrials (DJIA) — Green
- Russell 2000 (IWM) — Yellow
Those of us who have been put through the ringer a time or two have picked up a few tricks along the way to keep our heads on straight and our investments laser focused.
I want to share my top five ways to manage market declines that you can implement immediately.
1. Know the Difference Between a Pullback and a PlungeIn late February 2020, TradeSmith Finance’s Bearseye signal warned of a pending market collapse.
As the article noted, our backtested data showed that the indicator did a good job in forecasting severe market declines. The chart below shows the decline for the period after each Bearseye signal would have been triggered.
Now, we’ve made a pledge here at TradeSmith to let EVERYONE know if and when this signal triggers.
I use the Bearseye to define whether a decline is a simple pullback or the start of something worse.
On Monday, we saw markets teeter at the edge before producing a face-melting rally.
Having a technical indicator like the Bearseye under your belt is a tremendous advantage when you aren’t sure what to do. It keeps you in the market when you should be and lets you know when it’s time to exit.
Is it foolproof? Of course not.
That’s why we run so many tests on our indicators. History is all we have to inform our best forecast for the future.
And we’ve found that it’s best to stay in the market until we get a signal to exit.
Case in point: The indicator triggered on Feb. 27, 2020, right before the worst of the market crash.
We managed to get out in prime position, leaving us with ample cash so we could strike when the moment was right.
2. Don’t Try to Catch a Falling KnifeOn the flip side, we get the falling knife.
One of the cornerstones of TradeSmith Finance is momentum.
We understand that when momentum takes hold of a stock or market, it quickly pushes prices well beyond what you might consider “cheap” or “expensive.”
Even technical traders, those who study charts, can’t pick a bottom with 100% certainty.
Traders who move in and out of the market without an indicator find themselves taking losses because they don’t have data behind their decisions.
Even value investors look to things such as price-to-earnings (P/E) ratios to determine entry and exit points.
Like our Bearseye signal, the Bullseye signal lets us know when momentum has shifted to the bulls.
Between the Bearseye and Bullseye signals, I saved myself roughly 357.92 S&P points during the early 2020 drawdown.
Did they get me out at the exact top or in at the exact bottom? No.
The point of trading or investing isn’t to be 100% right. It’s to make as much money as you can over time.
I have confidence in my indicators because they have demonstrated success in backtests and when I used them.
Now, news traders and investors point to the Federal Reserve’s intervention as the turning point for markets. There’s a lot of truth to this, and I do generally incorporate the news into my decision-making process.
But markets are a lot smarter and faster at figuring out which news is important and which news isn’t. So I’d rather let the market tell me when to play ball.
3. Plan Ahead to Stay Ahead“Luck is what happens when preparation meets opportunity.” — Seneca
Markets can and will pull back, and they will crash. History shows this happens over and over.
Far too many people focus on trying to predict the next downturn, when they should be preparing for one.
With a little elbow grease, you can create your own playbook to whip out when the Bearseye triggers a warning.
I’ve previously laid out several strategies to use when markets begin to roll over.
One big key for everyone is to keep a watchlist.
Your watchlist should include stocks you want to own as well as stocks to use as tells for the market.
For example, back when the S&P 500 was forming a low in March 2020, we saw large-cap tech stocks like Apple (AAPL), Amazon (AMZN), and Shopify (SHOP) surge before the rest of the market.
The other key element to your plan is risk management.
I’m using this phrase broadly to mean your need to decide how much you want to risk and where, before we ever see the first inklings of a market decline.
Some folks can handle account drawdowns of 50%. Others rely on their accounts to fund living expenses and can’t afford such a brutal cut.
Take some time to ensure you choose a plan and strategy that’s appropriate for your goals and that you’re comfortable executing.
You don’t want to lie awake at night worried what the next day’s market might bring.
4. Manage Your Emotions ProactivelySpeaking of worrying, let’s talk about emotions.
Emotions influence every one of our decisions. Some of us are more susceptible to their influences. As Shakespeare wrote in “Hamlet,” “To thine own self be true.”
Be honest with yourself about whether you can make level-headed decisions when stocks are in a free fall.
News flash — most of us can’t.
That’s why having a plan is so important (see tip No. 3).
If you find it difficult to keep your emotions in check or feel overwhelmed at times, try these simple suggestions:
- Turn off the screens. Set up alerts based on your plan. Go do something else.
- Don’t bother with the news other than the main points. For most of us, a daily email roundup is just fine.
- Talk out your ideas with someone. You don’t have to take on this market alone.
5. Focus on Making the Right DecisionsWe can only control our decisions, not the markets. There is no amount of willpower that can force your favorite stock to stage a turnaround.
Trading and investing is an exercise in probabilities and decision making.
Not every outcome goes our way. That’s life.
All we can do is make the right decisions. Doing that time after time is what generates real wealth over the long haul.
Now, before I go, I want you to take an emotional inventory.
And I want to keep you honest.
So email me and answer two questions:
- What’s your plan for a market downturn?
- How will you manage your emotions?