July 6th, 2010

10 Commandments to Invest By

I usually post original content but I came across the following “10 Rules for Surviving Bear Markets” by John Lansing (even though I’ve disagreed with John on this site before, like when he recommended shorting GLD on January 9, 2009, when it was at 83.92 …. today it is 116.55) from OptionZone.com. He wrote the rules and posted them, interestingly enough, on March 7, 2009, the weekend of the market’s bottom.

While it may have been too late (and incorrect) to guide investors during the Financial Crises Crash and the terrific rebound out of it, the timing may be more appropriate today. I repeat it verbatim now because of all the discussion brought on by Friday’s “Black Cross” (where the 50-dma crosses under the 200-dma) in the S&P and the prospect of further declines over the near-term future:

  1. Good news in a bear market is like smoke in the breeze (i.e., soon dispersed): Don’t buy into analyst upgrades or recommendations. These can kill you. Every person reading this has access to some kind of trading platform, trading tools or systems that afford instant access to the financial markets. Good news like upgrades in bear markets typically has about five minutes of fame.
  2. Bear markets are not a time to learn how to “day trade”: A bear market is not a good time to try to learn how to day trade in an effort to recoup losses — no matter how many times you hear that “this is a traders’ market.”
  3. Accumulation days (there may be three or more in a row) are shorting opportunities: OK, accumulation days are shorting opportunities, but resist being aggressive until the S&P 500 (SPX) shows a 3-day and 5-day moving average bearish cross. Remember that it’s typically 50% market, 25% sector and 25% stock as far as direction. But some could argue that in bear markets it’s 75% index, 15% sector and 10% stock.
  4. Have sufficient, liquid funds: Over-leveraged and under-capitalized traders are also called “bear food.” Make sure you’re not edible. Reversal patterns mostly form in weak trends. If the trend that the market or stock you are watching has been strong, then chances are that any pause is just a consolidation before the next leg down.
  5. There is no such thing as “safe sectors”: Sure, each bear market brings sector rotation. But make sure if you are playing this game that you don’t have the flexibility of wood. And when the music stops, quickly find a chair! What I’m saying is that you must be flexible so you are able to change with the markets. The best traders are those who are nimble and approach the markets without bias.
  6. Your stop-losses are YOUR stop-losses: The pain of being down 8% in a bull market is no different than being down 8% in a bear market. If your risk tolerance requires you stopping out at 8%, then be consistent in any market you trade. It takes greater emotional balance to trade a bear than a bull. So, always manage your risk — just remember that, in the markets, your money is always at risk. Great traders manage emotions and risk. Only you know your risk tolerance, and it’s you who controls what happens between the keyboard and chair.
  7. Bear markets are generally slow-moving affairs: However, stocks in bear markets can move much faster than you think, which is the reason that volatility rises drastically. But we need to keep the time we spend in a bear in perspective. Unfortunately, bear markets last much longer than most are willing to wait, and they move their money to the sidelines.
  8. Market capitulation is very difficult to measure: Market capitulation is more a state of mind than a specific set of market conditions. Hence the market maxim, “Bear markets end when the last bull throws in the towel, not when bears turn bullish.”
  9. Bear markets drain emotional capital much faster than bull markets: Bear-market volatility will suck your energy at twice the rate of a bull. Rule: Take twice as many breaks from trading the bear as from trading the bull.
  10. Have sufficient, liquid funds: Over-leveraged and under-capitalized traders are also called “bear food.” Make sure you’re not edible.

A Bear-Market Rally is Not a Bull Market. In general, we all want to be bullish, and are eager to see any upward market movement as a rally, even when it’s not…..Regardless of your current opinion, you are best-served by feeling with your heart, while investing with your head. Are fear and greed driving your investment decisions right now, or are you in control of your emotions? If you’re not sure, I’d recommend taking a step back and looking at the market from a different angle … an unemotional one.

Print this out and save it above your monitor so you have it as a reminder as you place your trades.

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