4 strategies for this market

In
last Wednesday’s column, after discussing all the things I thought were wrong
with the market, I stated that I am now trading in “bear-market mode”. Today I
will expand on that and discuss what it entails.

First, let’s list some characteristics of bear markets:

1) Increased volatility — Markets are emotional. Bull markets are driven by
greed. Bear markets are driven by fear. Since fear is a more powerful emotion,
it tends to lead to more rash decision-making. The result of this rash decision
making is increased volatility. The more panicked and irrational people get the
more volatile the whipsaws will be.

2) Market rallies are generally sharp and brief — Panic selling leads to panic
buying. Part of this is due to short covering and part of this is due to
investors desire to catch a bottom.

3) Everything goes down eventually — Ok, not EVERYTHING. There will be some
winning stocks. All sectors will eventually feel the pain, though. Groups that
typically don’t correlate will begin to correlate as selling takes hold
everywhere. Not just among stocks, but across most investment vehicles. Stocks
go down, bond prices go down, and commodities go down — pretty much everything.
Part of this is due to the fact that money is not simply taken out of the market
during a bear, it is destroyed. This is done in the opposite way that bull
markets create money. For example, if a certain market or trading vehicle has a
market cap of $1,000,000 and a large investor or group of investors decide they
want to cash out for say $50,000, they will not simply sell their shares for
$50,000 and have the assets transferred to someone else. Instead, they will
begin liquidating. In an era of declining prices, this will force the price of
the market down. By the time they are able to liquidate their $50,000 position,
they may have pushed the price down to a point where that position is only worth
$45,000. This is not a $5,000 effect on the market, though. In pushing the price
down, the price of everyone else’s shares has also been affected. Therefore, the
$1,000,000 market cap is now $900,000. $100,000 of market cap has been
destroyed. If the other market participants now want to cash out and move their
money elsewhere, there will be less of it to move. This destruction of money
means there is less money to invest anywhere, and therefore all markets are
eventually affected.

Now, below are a few ways that you make look to take advantage of a market with
these characteristics:

1) Concentrate of shorting — Any time the market bounces you should be looking
for opportunities to short. This is especially true of sharp bounces. They fool
the most people and create the easiest opportunities.

2) Play the overreactions — Increased volatility and fear, brief but sharp
rallies, and panic sell offs lead to over-reactions in both directions. Think
like a contrarian and you’ll find some nice opportunities.

3) For longs, focus on playing oversold reversals rather than buying breakouts.

4) For longs — shorten you time frame. Take profits quicker. Don’t assume the
reversal is going to lead to s sustainable rally. Instead, take you profits and
wait for the next opportunity.

That is what I mean by “trading in bear market mode”. Are we in a bear market? I
don’t know. I do know the market has been trading like one. The UUWNHI
(Unofficial, Unscientific Working/Not working Hanna Indicator) is saying that
bear market strategies are beginning to work. Therefore, until the market looks
to be turning up, that’s where my focus will be.

Best of luck with your trading,

Rob