Developing a Strategy for a Very Difficult Stock Market

Anyone that started trading since the 2008-2009 recession and bear market is likely dealing with the most difficult market environment they have ever seen. I’ve documented on Real Money how a stealth bear market had been operating in many stocks since February 2021, and now it is spreading to the broader market and creating elevated volatility.

There are many different approaches to dealing with challenging markets, but the biggest problem is that most people do not have a clear strategy. When there is no plan in place, then emotions take hold and drive decision-making.

The first step in dealing with a tough market is to be very clear about your style. Are you a long-term buy-and-hold investor looking to accumulate blue-chip stocks? Are you a trend follower looking to ride strong momentum? Or are you an aggressive trader looking to play short-term volatility?

There are many different styles and approaches, but if you aren’t clear about what you plan to do, then you will make emotional and suboptimal decisions.

My style is a combination of stock-picking, momentum and technical trading, and it does not work very well in this current market environment that is driven primarily by macro flows, rotational action and computer algorithms.

With that in mind, my current strategy for this poor market is as follows.

1. Stay highly reactive and do not spend much time trying to predict what might happen next. Many people spend time and energy complaining about the horrible market, which may provide some emotional relief, but it is not productive. The market always has and always will go through cycles. Miserable market action is just the nature of the market beast at times. The future will take care of itself. Focus on managing what is happening today, which is the only thing that you can control.

2. Maintain a high level of cash. There is no benefit to building big positions in a poor market. When there is a clear turn and some sustained upside, there will be plenty of time to put money to work. Traders often fear that if they don’t put money to work into the teeth of a decline, they will miss out. That just isn’t the case. When a bull market environment develops, it will last weeks or months.

3. Keep stops tight, and don’t let bad positions grow too big. If a trade doesn’t work, then take the loss and try again. It will be frustrating to keep taking losses on trades, but if they are contained, then it is just the price of insurance. You do not want to keep adding to losing positions in a poor market. Wait for strength, and then be aggressive. Recent lows are often good stop-out points.

4. Fundamentals will not protect you. One of the biggest frustrations in this sort of action is that great stock-picking does not matter. As we have seen, computer algorithms will sell everything in a sector regardless of its merits. Eventually, these stocks will find some buyers, but there is no way to know when. I keep positions in some favorites and…