Experienced traders realize a fundamental truth: you cannot pick the type of market you are trading in, you can only identify and adapt, to successfully trade in current market conditions.
Last year, the overall market put on a tremendous show. The S&P 500 index was up over 30% on the year; every sell off seemed to be viewed as a buying opportunity, with those who got nervous and sold out, punished and subject to self-mockery within weeks or sometimes even days of exiting their long positions.
So far this year it has been a different story. We discussed how, historically, January has proven to be a good indicator of annual market performance. The January effect has observed that if the first 5 days and the month was lower the annual performance follows and is lower 70% of the time. Well, the first 5 trading days of the year were down and the month of January put in the worst monthly performance (down 3.5%) since May of last year. This result should caution investors that the practice of buying the dips which worked so well in 2013 might be the wrong thing to do in 2014.
So what should you do? If you take your ball and go home, well, then you miss out on a day like yesterday where buyers emerged looking to scoop up bargains and caused prices to rebound significantly. This is where it makes more sense to adapt to conditions, rather than just giving up and getting out of everything.
The market is moving more each trading day. That is a fact. Look at 10 day historical volatility which has increased to 19.5% from single digits (7.25%) the first days of January. The first thing a disciplined trader should consider is reducing his trading size. If you used to trade 50 lots, consider trading 25 contracts. If you were a 5 lot trader, open your new positions with 2 or 3 contracts. Trading smaller allows you to work your way into the trade rather than spending your entire investment capital you are allocating to any one trade in one fell swoop.
Secondly, consider shortening your trade duration. If you had been looking to hold a swing trade for 3 days, chances are the performance of that trade may occur in a much shorter time period. Buying-and-Holding is dangerous when the markets begin to get more volatile.
And lastly, consider using options to have HEDGED exposure to market moves vs. straight stock buys and sells. OptionsHouse will be presenting a webinar this Tuesday discussing various option strategies which can be employed in today’s volatile markets. I strongly urge you to check it out.
The market is whipping around. Be prepared by adapting your trade style.
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