Try These Two Minor Adjustments
Any
doubt that the market has been struggling was erased today. All
of the major averages have now broken key support levels. Few stocks have escaped
the recent selling and leadership has begun to break down en masse. The
VIX has spiked dramatically over the last two days, increasing the odds that a
short-term bounce is likely soon. If you haven’t taken on any short exposure,
I might wait until that bounce has occurred before betting too heavily. In a market
environment like this, defensive positioning can become very important.
Today I will continue my series
on profit-taking to discuss how traders can adjust their strategies
according to market conditions. For those of you that missed my previous two
articles on this topic (Feb.
23 and March
1), you may want to go back and read them.
As a quick review, I established that although we would all like to be able
to sell at the top (or cover at the bottom), it is impossible to design a profit-taking
methodology that consistently does this. Therefore, profit-taking strategies
fall into two categories:
1. Those that look to sell too early.
2. Those that look to sell too late.
There are pros and cons to each type of strategy. Having understood
them, the vast majority of traders will find they are most comfortable with
a combination strategy. A combination strategy allows them to sell a part of
the position on the way up (too early), and the rest of the position on the
way down (too late). They may therefore reap the rewards of both strategies.
I’ve always been of the opinion that market analysis,
even when correct, does the average trader very little good. Part of the reason
for this is that most traders don’t understand how they should adjust
their trading based on market conditions.
I’ve said in the past that I believe a trader should take
the trades that meet his criteria, regardless of his (or her) market opinion.
When they perceive market conditions to be unfavorable to their style of trading
then additional steps should be taken to help protect against losses. These
steps include demanding the best setups, trading reduced position size, and
adjusting stops.
Let’s look at how stops may be adjusted based on market conditions
in the context of the profit-taking strategies we’ve been discussing.
For a trader that typically uses a mix of say 50% “too
early†and 50% “too late†for their profit-taking strategy,
they should increase or decrease these percentages as their perception of the
market dictates. If you are being stopped out of a lot of trades and seeing
many of your winners turn into scratches, and your perception of the market
is that it is currently unfavorable to your strategies, then you could consider
taking a larger percentage of the trade off “too earlyâ€. Perhaps
75%-25%. In favorable market conditions you could do the reverse — take
profits on 25% “too early†and 75% “too lateâ€. (Percentages
are just for example. You should use whatever percentages you feel most comfortable
with.)
By making minor adjustments such as these you will allow yourself
more opportunity for large gains when market conditions are favorable, and will
be better positioned to control drawdown and do some quick profit-taking when
conditions are unfavorable.
Good trading,
robhanna@rcn.com