Alan Farley 2016年2月26日
Common Sense Strategies For Adverse Markets
By Alan Farley | February 26, 2016
Financial markets cycle continuously between benevolent periods that offer easy profits and tough times that trigger unexpected damage to investment and trading accounts. Market players need to make skillful adjustments in adverse periods to manage risk, protect seed capital and generate targeted profits while waiting for the return of benign conditions.
Volatility tracks adversity, with the rising S&P Volatility Index (VIX) reflecting broader daily and weekly price swings, diminished liquidity and the tighter correlation between equities, currencies, bonds, and commodities. The alignment between dissimilar markets confuses participants because it exerts a greater influence than easily observed support and resistance levels, easily triggering well-placed stop losses.
Dealing With Adverse Markets
Adverse conditions can occur in rising or falling markets, but falling markets do greater damage due to the bullish bias of most investment strategies. Short sale and hedging practices allow a proactive response but tend to fail over time because markets fall more quickly than they rise, with sideways chop targeting long and short positions for weeks or months at a time.
The most effective strategies rely on strict self-discipline that lowers the size and frequency of trade execution, keeping cash levels high until the return of favorable conditions. This is easier said than done because it’s hard to recognize the improvement until it’s well underway, as we saw in 2009 when analysts predicted new lows for nearly a year after the March bottom.
Discipline also needs to manage emotions that translate into unwise decision-making. Markets move higher and lower through the qualities of greed and fear. Fear rises significantly in adverse markets, testing personal qualities that rarely come into play in day to day living. The fear factor can be devastating at these times, contributing to life-changing choices that can wipe out family wealth.
Market wisdom tells us that cash is a position too. Adverse markets demand a short-term zero-out trading approach that takes targeted exposure when opportunities show up and then returns to 100% cash as soon as a conservative profit target is reached. This contrasts with the popular trend following strategy of letting your profits run.
Traders should cut execution frequency by 50% to 75% while investors sit on their hands, waiting for large scale cyclical turns. These folks also have to manage exposure carried into the maelstrom, deciding if the risk is worth holding through tough times. This can be a million dollar decision, with some periods of adversity easing after a few weeks or months while others last for years.
This is especially true when adversity strikes a market segment, such as the commodity complex, while sparing the broad averages. Many investors built large exposure to energy stocks between 2010 and 2014, just before the group sold off in the worst downtrend in generations. Even worse, many took an additional risk while the group spiraled lower, trying to pick bottoms.
These can be life-changing decisions, with no easy answers. Many times, the best course of action just capitulates and takes the loss, going back into cash poorer but wiser. This has an added psychological benefit, allowing the humbled investor to say goodbye to positions that caused high-stress levels and sleepless nights. It also frees up capital for new opportunities.
Take A Giant Step Back
Shift the focus away from the daily grind focus your attention on longer time frames. Turn off the financial television and pull out spreadsheets and charts, examining weekly and monthly performance. Bear markets, corrections and other periods of adversity tend to follow similar paths that can be analyzed using VIX and other volatility indicators. These are more easily seen when taking a giant step back and looking at the big picture.
Become a big game hunter. Securities that you’ve wanted to own for years can often be bought at bargain basement prices in adverse markets, as long as you’re patient and willing to build positions at a very slow pace. These legendary trades come infrequently but can be life savers when they show up, filling depleted coffers while restoring confidence in investment decisions.
Master New Strategies
Each market environment creates its own set of opportunities, and it’s no different when adversity hits the ticker tape. It may be a perfect time to learn the art of short selling, using relief rallies to enter positions, in hopes of profiting from lower prices. Rotation also lights the way as funds exit hot plays and allocate capital to niche market groups that can outperform during these periods.
Look at defensive sectors to see if they’re countering broad market price action. Specifically, are utilities, food, and tobacco attracting buying interest due to their reputations as safe havens? In addition to less cyclical business models, these securities pay high dividends while grinding through smaller average ranges, lowering the risk of getting stopped out during volatile periods.
The Bottom Line
Adverse markets require skillful adjustments to reduce risk and find new profit opportunities. Start by building cash levels to 100%, if possible, and then carefully reallocating capital into defensive positions.