When the stock market is in a strong uptrend, it usually lifts all boats and gives investors plenty of room to run with their stocks.
In a sharp downtrend, MarketSmith users know to stay away until the trend changes.
But there are times when the markets are choppy and making a profit — even a small one, not the 20% to 25% variety — is frustratingly difficult.
If you are trading a lot and your market timing is poor, you risk dying a death by a thousand cuts, losing small amounts of money on trade after trade.
In some years, the indices march higher in an irregular fashion, first dipping into a correction, then bolting out of it to a new high. And then there are times when the indices do not make any progress – just like how the Nifty has behaved this year. The 50-stock composite closed at 10,741.55 on January 15. On June 21, it finished at 10,741.10. That’s 108 sessions without any progress (1).
Now, there are several things you can do to handle choppy markets.
First, it is important to understand yourself. An experienced trader knows how the twin emotions of fear and greed play on him or her.
So, one obvious choice is to stay out of the market and wait for a better climate. If too many trades are going against you, step aside.
Second, take profits and losses more quickly. Instead of taking losses at 7-8%, cut them down to 3-4%. By the same token, lock in profits at 10-12% instead of 20-25%. That way, you maintain a 3-to-1 profit-to-loss ratio. To make this work, you have to be laser-focused on buying at the exact buy point. If you are buying a stock more than 5% above the ideal buy point, a normal pullback will shake you out.
Third, avoid being fully invested or using margin to buy stocks. If trades aren’t working for you, you can lose money much faster on margin than if you are trading with a limited amount of your money.
When the market reverses trend and gets into a Confirmed Uptrend, buy stocks coming out of tightly-formed, sound bases with solid breakouts and superior fundamentals. You are only buying quality merchandise. Those are the stocks that are hardest to suppress in a choppy market. Avoid late-stage bases.
The Indian market went through an especially choppy period in early 2015 (2). And this year, so far, is shaping up the same way (3).
While frontline indices have shown resilience, they have remained range-bound for quite some time. Also, weakness has been mainly witnessed in the midcap and smallcap space.
Some of the stocks added in our model portfolio from largecap space have done quite well for us. However, most stocks from smallcap and midcap segments have given failed breakouts in the current choppy market. This has forced us to cut our positions on them.
As investors, we all hate cutting losses and hence it is the most difficult thing to do in the stock market. However, if done at the right time, it also helps you in preserving capital.
Losing a few battles will hurt you, but what’s more important is to survive. You might lose a few battles when the markets are choppy, but the only thing that matters is surviving tough periods and fighting back to win the war.
To prepare ourselves for the next uptrend, we will be discussing a few fundamentally strong stocks that have displayed resilience in the current choppy environment in our upcoming bi-weekly webinar. The one-hour webinar will be held on Tuesday, June 26 at 6:30 P.M. We look forward to your participation. Here’s the link to register for the webinar.
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