Today’s Trading Lesson From TradingMarkets

Brice

TradingMarkets.com

One of the most important lessons that a
successful stock investor needs to learn is that there are times when the market
is presenting plentiful, low-risk opportunities and there are times when making
money in the markets is quite difficult and far less certain. Adjusting one’s
strategy for these different market environments is key. You can trade
aggressively in a terrific market environment and make triple-digit annual gains
with ease. But trading just as aggressively in a very difficult market
environment could result in a huge drawdown of capital. Remember that a 50%
drawdown erases a 100% gain, and requires a 100% gain just to get back.

Over the years, one of the most common stories
I’ve seen is for a smart investor to begin investing very aggressively during a
strong market run-up when the environment is fairly easy pickings. This smart
investor will have a strategy that exploits the good environment quite well —
and he’ll typically make huge gains of around 500%-1,000% on his money in a one-
to three-year period. But when the market environment changes, this investor
refuses to change with it, and in the following one- to two-year period, the
investor loses most or all of his trading capital. Witness Foxhound funds’
recent wipeout — a leveraged 300% gain in 1999, but a total 100% loss of
everything by April, 2000.

Clearly, learning to understand when one can be
aggressive, and to understand when to be defensive is important to investors
desiring to maximize gains with minimum risk.

We’ve already discussed (in prior lessons and
courses available on TradingMarkets.com) some macro tools investors should watch
— like interest rates, market breadth, and timing models both short and
long-term — to help distinguish an environment conducive to aggressive vs.
defensive trading. In addition, investors should watch carefully the number of
flag and cup-and-handle breakouts or breakdowns in stocks with upfuel or
downfuel to see how abundant the market’s opportunities are.

Probably most importantly, investors should watch
carefully our daily list of
Top
RS New Highs (on TradingMarkets.com) and the groups and sub-groups based on
this list as well as the

Bottom RS New Lows and the groups and sub-groups based on it. When the list
of Top RS New Highs is more than 20 stocks every day and there is clear
leadership in several groups that are broadening with more and more new highs in
that group each day, the environment is more conducive to aggressive buying.
Conversely, when the list of daily Bottom RS New Lows is more than 20 stocks
every day and there is clear downside leadership in several groups with more and
more new lows in those groups each day, the environment is conducive to more
aggressive shorting. When Top RS New Highs and the number of issues in leading
groups thin out, the environment is one to become defensive toward on the long
side. And when the Bottom RS New Lows and the number of issues in lagging groups
making new lows thins out, the environment is one conducive to becoming
defensive toward the short side.

Until early March 2000, both the short-side and
the long-side showed broad participation and seemed to be indicating an
aggressive posture. However, beginning in very early March, the environment
began to change abruptly. Top RS New Highs began to thin out to under 20 issues
and the leading groups began to show fewer and fewer new highs. Similarly on the
downside, Bottom RS New Lows began to thin out to under 20 issues and the
lagging groups began to show fewer and fewer New Lows. This is why, in early
March, when we had been previously advising fully leveraged shorts and longs, we
advised investors to take half profits on all positions. Leadership was failing
and the opportunistic environment was at a sea change.

Since early March, the stock market environment
has changed. There is no clear leadership on either the upside or the downside.
In addition to reducing leverage, tightening up trailing stops, and taking 1/2
profits on all positions, investors need to trade more defensively in their
approach going forward until a better environment returns.

In future lessons, we’ll discuss a number of ways
of becoming more defensive while still leaving ample room for profiting from
market movements. But a huge part of knowing when to trade aggressively and when
to cut back is revealed simply by watching carefully the breadth and number of
flag breakouts and cup-and-handle breakouts to new highs in stocks with upfuel
on our Top RS New Highs list — and in watching the leadership and breadth of
stocks and groups on these lists over time. Similarly, a huge part of knowing
when to trade the short side aggressively or when to cut back is revealed simply
by watching carefully the breadth and number of downside flag breakdowns and
downside cup-and-handle breakdowns to new lows in stocks with downfuel on our
Bottom RS New Lows list — and in watching the downside leadership and breadth
of stocks and groups on these lists over time. These lists are some of the most
incredible tools available to investors anywhere.

Click Here To Learn How Mark Boucher Has Been Successful For The Past Decade