When I first started trading, my account was too small for me to do much beyond utilizing a “single-buy, single-sell” approach. However, as I gained experience and my account grew, by far, the biggest advance I made in my skill as a trader was when I started focusing more on making partial buys as stocks that I favored pulled back and partial sells into any subsequent strength.
Unfortunately, too many investors have the mindset that weak markets are categorically awful, and that the only good market is one that only goes up without pause. Of course, that’s just not the way markets work, and the good news is that, by accepting the inevitability of market cycles investors can truly embrace the need for bear markets and take full advantage of the opportunities they create.
Accordingly, it’s important to understand that the worst market corrections occur in a correlated manner. We saw that during the 2008 financial crisis and we’ve been seeing that throughout the first three quarters of 2022. Stocks are sold without regard for their individual merits and there’s simply nowhere to hide. When the S&P 500 or the Russell 2000 ETFs get sold, then every stock in those indices is also sold. Thousands of ETFs trade large buckets of stocks, and the good are thrown away with the bad when that happens.
That is the key to the great opportunities that bear markets (and even minor market corrections) create, especially for those who use multiple layers when assessing individual names. Charts obviously help, but by understanding the unique situation of a particular company’s stock and its fundamentals, you can appreciate which stocks hold the best potential for strong upside as a market correction comes to an end.
Identifying those names is only the first step. I tend to gravitate towards stocks that have less of a following and that I feel have some unique aspect that will eventually allow them to move higher. Once I identify a name that I feel has strong potential, I’ll learn as much as I can about the company and the catalysts that could create movement.
From there, managing that position is all about timing and size. Typically, I will start with a smaller position in order to make sure the stock is on my radar. Having a not-insubstantial position requires me to watch closer than I might otherwise and helps me develop a sense of how it trades. This approach has also forced me to get comfortable having names in my portfolio that might make pure chartists cringe, but I’ve found that many of these have become my biggest winners as I trade around a core position and as I take larger size during a period of market weakness.
One issue that many traders run into is that they’re holding too much of a favorite name when the market corrects. It creates a dilemma in that they don’t want to buy more and build an uncomfortably large position, but at the same time, they don’t want to sell because they don’t want to lock in a loss in a stock that they have a high level of confidence in.
I’ll deal with this by setting partial stops on those positions but have a firm plan to rebuy as the broader conditions develop. This is particularly useful in bear markets as both downdrafts and counter-trend moves tend to be exaggerated. It’s not important if I rebuy higher or lower. What matters is that technical conditions are better and I have a higher level of conviction.
One of the great benefits of making partial buys and sells in these types of positions is that it helps you maintain an opportunistic and optimistic mindset. There is always the chance that you may have made a bad pick, but the reduction of the position size allows you to manage risk until the stock proves itself again.
There are a number of stocks that I favor right now that have been acting poorly along with the broader market. I have raised a substantial cash position, but my plan is to deploy that cash and build back those positions as soon as market conditions improve and potential catalysts approach. I’m watching them carefully and my optimism only increases as they break support and cause a chorus of complaints.
The key here is that market cycles will always exist, and those who embrace both strong and weak markets will be rewarded. Managing risk is our job as traders, but it’s just as important to make sure we’re in a position to take advantage of the next cycle.
