How does one become a champion in THIS market...?

This is a tough market. No question about it. In this market profits can vanish in an instant even is someone is right on the fundamentals. If you were long double short ETFs the last week or long a stock that got a bad rap there was nowhere to run and nowhere to hide, baby.

But smart investors can still be champions in this mkt. In fact, the savviest investors often like these markets the best because they create the most OPPORTUNITY. But these conditions also have the highest risk. So I compiled a list of rules I like to use, a guide if you will, for navigating markets like this. If others want to agree or disagree please feel free. I welcome it.

Rule #1: CASH is KING.
A lot of people, especially young and/or inexperienced investors, get inpatient with CASH. It doesn't earn much, especially in this market and we all know that stocks beat savings deposits and the like in the long run. But Cash has a lot of advantages. I mean a lot, especially in a market like this.

First and foremost not losing money is as important if not more important than making money in the the overall performance. It's like playing good D in the NCAA tourney (which btw my alma mater did NOT win despite getting to the Final Four for the third year in a row... but that's another story). Without it you can't win. I don't care what anyone tells you about how they enjoy getting into high risk/high reward stocks that are going to shoo the moon. This may sound hard and cool but the reality is that is just gambling and if that's what you want go to Vegas. Smart investors and traders are always looking for the highest return with the LOWEST RISK. In a market like this the risk is high no matter whether people go short or long, invest in commodities, stocks, options, bonds, futures, etc. The fear in the market makes it volatile. The greedy and inexperience shorts are ripe for the picking by more experienced veterans. It's just that simple. With CASH the risk is ZERO. That's right Zero.

So that may be obvious but what is less obvious but equally important is that holding cash can create the greatest possible returns even if your crappy broker is paying you pennies on the dollar to hold cash. How does that work? CASH allows someone to take advantage of OPPORTUNITY. In this market opportunities abound. There's a reason why guys like Warren Buffett love bear markets. They have the cash to take advantage of FEAR on the long side. The reality is that in a bear market like we are in many stocks are not cheap despite p/e ratios because earnings are being overestimated. But there are always great stocks whose earnings will not come down that get thrown in with the rest. Did you have the cash and the insight to get into ISRG (one of the best secular stocks in recent history imo) when it fell to 250? What about POT when it was down in the low 100s? These screaming deals only happen in this market. The cash allows the play to be converted into points. In a market like this I like to hold, on average, no less than 40% cash and often much more. Right now for example I have 80% cash. The cash also allows one to play short positions as it allows rapid covering if necessary an liquidity to move money if necessary. Also, in this market it helps tremendously PSYCHOLOGICALLY. It's a tough market because stocks often move in ways that are very difficult to predict in the short-term. If someone has too much invested swings in holdings can be grinding and can cause people to make bad decisions over time. To be involved in any way successfully one has to be able to sleep at night and that requires a healthy helping of CASH.

Rule #2: Did I mention CASH?
Rule #3: Trades/Shorts are like vitamin supplements: they can give a boost but are not the main course
*EXCEPTION: An experienced/professional trader who knows exactly what he/she is doing.
There is no jungle like the trading jungle and you are doing battle against the best here...

Notice that I mentioned trading and shorts together. That is because shorts are ALWAYS trades. Ever hear anyone tell you that they want invest in the QID for he next 70 years? No way... dude... Stocks go up over time. They always have and always will. Somewhere in the world at least! But there are periods where they go down and even if someone holds short instruments for several weeks or months they are always short term trades and profits should be taken accordingly imo. Whether short or in long trades these are volatile and the risk is higher than long term investments. Sometimes much higher. That is why I don't recommend putting too much capital into trades at any one time. The result of a successful trade is duh to take back more cash than was put in but the near term objective is always to return to the cash position. Get in. Get out. Get on.

Shorts are more dangerous than long trades because the downside is theoretically infinite. That's why some people I respect have a rule of no more than 5% of positions in short instruments at any one time. I am not quite that conservative. But I do feel like having no more than 15% in shorts of individual stocks as opposed to ETFs (with no more than 10% in any one stock at one time) is a decent rule of thumb. Of course it depends on each person and what they can afford to lose and the risk they are willing to take. Also it depends on the stock. Still it is easy to look at a stock that just HAS to go down and get too aggressive and even worse use (HEAVY LEVERAGE,,, see more later) only to have the stock do the unthinkable. Unlike stocks of good companies which are likely to eventually go up shorts in many cases are likely to do just the opposite over time. For short ETFs I feel comfortable going a little higher but especially for leveraged ETFs 30% or so is a top level for me. That is total in all short ETFs combined.

In terms of long trades again my own rule is to try to keep no more than a total of 40% of my assets in a combination of long trades and total shorts at any one time, with pre-determined stops (often actual stop trades, sometimes a number at which I will move in and sell) so that the maximum possible loss is always known. It is also a good idea to know about where you would like to sell all or some of the position if it goes up. What would you consider enough? Trailing stops often help insure that at least a minimum gain on some or all shares is achieved if the stock moves. Another part of this, a rule which I violated (much to my chagrin) on the TWM is to never let winning trades become losing trades. This is always true for a very short-term horizon. In some cases for a medium term position I feel it is ok to put the stop just below a key support area to prevent stopping out from shear volatility. However, fairly tight to always prevent winners from turning into big losers. Just put stops or get out if the winning trade hits the minimum profit range.

This is one area where long investments differ from trades: In long investments sometimes it is ok to be down quite a bit if one has a long-term projection and is slowly building a position. In trades the point is to get out and take the gains or cut the losses quickly and move back into cash. Being down big on a trade is not generally a good idea. I find that when I follow these rules I am oft much better off than when I do not. Of course the amount dedicated to trades/shorts can change depending on conditions. Note that I find 40% of total investing assets to be quite high. Often (usually) much less is apropos.

What do I do with the rest of my cash in a bear market? I still like to invest small amounts in great long-term companies that are either not likely to be heavily affected by the economy or that have been overly beaten up. I like to build core positions, slowly and in pieces, in companies such as POT, CME, CMED, NYX, etc. when they reach bargain prices that represent solid long-term value. If they don;t hit my target I don't buy. I essentially try to sift through the garage sales to look for OPPORTUNITY. Just like in a bull market but more discerning. MUCH more? Depends on the market. This is a buyer's market so only buy when the prices are steals and have no problem trimming/eliminating positions when the markets get too exuberant (profit taking). Additionally it is always worthwhile to check out biopharma/drug companies and the like. If these companies hit a blockbuster the charts show that they often go up regardless of overall economic conditions. This is a risk so very small positions only unless I know something I feel others do not. And it only takes one or two successes for large upside
Since I have a background in biochemistry I am particularly inclined to look at these kind of companies. "Invest in companies that you understand".

Rule #4: Leverage is a double-edged sword.
One only has to look at the credit/subprime/ soon to be prime/ etc. mess to see this. Still it is easy to sit here and call those very intelligent Hedge fund managers at LEH and MER etc. a bunch of greedy idiots and then turn around and do the EXACT same thing on a lesser scale ourselves. BE CAREFUL. This post, from a guy who knows what he is talking about (despite being a bit vulgar at times... oh well can't have it all)... puts it as profoundly as can be and made me shake in my boots and think twice for a second...

Rule #5: The stocks of great companies go up in the long run.
That is because in the long run stock prices follow earnings and earnings projections. The long-term projection of the US stock market has always been up. At least so far. With globalization and advances likely to come in many many fields in the future this is likely to continue to be the case. Especially if one is willing to look at foreign stocks. For this reason any bear market, even the worst ones, ultimately serves as a hiatus from the bigger picture. It is always important to realize this imo. The best investments are the one that have the maximum track record for success with the lowest RISK. It's a good bet that good stocks will go up in the long run. Especially if they are undervalued. That is why imo it is important not to get too caught up in the short-term and short selling/swing trading mentality unless that it what you do for a living.

Bear markets offer something that bull markets often don't: time to find great companies while they are getting cheaper, not more expensive. These markets offer a great opportunity to search, dig, learn, watch, etc. stocks and companies from all over the world for when the time is right. That is why I appreciate posts like 50 billion cents' post on Brazil. Do I feel like going long too many or even any of these companies right now. No. But do I see some of these as great companies that are worth knowing about and that would possibly/probably go up a lot during the time it takes me to investigate them in normal markets. Yes.

Rule #6:Always look for the early or next bubble formation/ long term bull market.
Cash needs to go somewhere. And somewhere there is always something new and not yet exposed or overplayed that is going on. Right now? Feed stocks in China? Infrastructure plays in developing nations? Food commodity futures? Plays on the emerging rich in Latin America and Asia? Aiports in Mexico? Currency plays in RMBs? Gambling in Macao? Sanitation companies in Brazil? Railroads in China? Desalinization plants in the Carribbean? Commerce between Australia and Asia? These are ideas, some of which provide opportunities now, some which may in the future, and some which will never pan out. But it is always worth thinking about and looking for...

Rule #7: Trends are your Friends
No matter what you think the trends are powerful and it is important imo not to fight them. Long-term right now we are clearly on a downward trend. The chart is about as clear as any I have ever seen. Recently we have been in an uptrend that I think will turn soon. However, until it does I wouldn't fight it too much. However trends exist not only in the overall market but within segments. I am always looking to trade time for cash if it just that easy. What does that mean? Typically stocks tend toward the mean short term. This opens up opportunities for oversold/overbought indicators in conjunction with other factors such as a change in MACD, etc. Stocks trend up long-term. Ever notice that in a bull market top stocks like AAPL trend upwards before earnings? By looking at the past it makes sense in those conditions to get in sometime before and take some or even all out (profits) before the actual earnings. That is money with very little risk. Cash for time. In a bear market for companies that have been oversold we may see the same thing. For stocks that have missed recently and people are afraid will disappoint it may be worthwhile to look at and consider shorting a little going into but always getting out before actual earnings. Another one? Notice that when MOS blew away earnings POT went up also. If there was a lag and one got in quickly enough this is a very high probability trend trade. How about going short the trucking and airline stocks when the low oil inventories came in. There are many many more and I am always looking for such trends and if others want to share that would be great and helpful to all as well...

Rule #8: Balance and the Pursuit of Happiness
This really pertains to much more than a tough market like this. It is very difficult to be successful long term if something is out of balance. If a person is not content. Doesn't have joy. Doesn't make time for himself/herself. Doesn't step back and realize the big picture: which imho is: That the meaning of life for many if not most is LIFE ITSELF. If one gets too obsessed with minutae such that the fundamental principles that make us human gets skewed it will cost. In a market like this especially this will eventually have an adverse affect. This is perhaps the most important rule of all...

There are many many other good ideas. Stay ahead of the curve. Know what others don't etc.
Those are the tips for myself and for others. I hope to keep learning and growing in the best possible way and that others do the same.

Best,
Jon


This blog is for informational purposes only. It does not give investment advice.