I’ve been trading for 16 years. For the first 12 years, I would do very well during market uptrends, only to give back a good deal of profits during the corrections. I made one simple adjustment over the past 4 years: When I see potential warning signs, I now go to cash and SIT OUT! If I’m wrong, I could care less because I’m confident that I’ll make the proper adjustments and get back in the market, even if it’s at higher prices. I stopped worrying about “the fear of missing out” (which is the downfall of most traders) and I got more concerned with respecting risk and playing defense. MY NUMBER ONE PRIORITY IS TO PROTECT CAPITAL…PERIOD!
Whenever I move to cash, I get the same questions over and over: Why don’t you short? What do you do for money? Why don’t you daytrade? My simple answer to all these questions is: DO WHAT WORKS FOR YOU! My more detailed response is the following:
1) I am a trader, not an investor. The market is healthy 2 to 3 times a year. When I feel we’re in an uptrend, I trade companies that are both fundamentally and technically strong. When I see warnings signs, I get out!
2) One of the main reasons I STAY out during corrective markets is that 4 out 5 stocks move in the general direction of the market. In other words, if we are in a downtrend, I don’t care how good the company is because most stocks will get hit.
3) I’ve studied some of the best traders who ever lived, such as Jesse Livermore and Gerald Loeb. They believe that you should only be in the market when probabilities are in your favor, and that the LESS you are in the market, the better. According to Harvard Business Review, since 1886, the US economy has been in a recession or depression 61% of the time. I realize that the stock market does not equal the economy, but they are somewhat related. Again, I only want to be in the market when I feel it’s healthy.
4) In my opinion, 90% of what we’re taught about the stock market is flat out wrong: dollar-cost averaging, buy and hold, buy cheap stocks, always be in the market. The last point has certainly been proven wrong because we have seen two declines of over -50%…just in the past decade! Keep in mind, it takes a +100% gain to recover a -50% decline.
5) 95% of individual traders lose money over ANY 10-year period. Why? I could write a book on the many reasons why I think this happens, but one reason is their inability to sit out (trust me, I struggled with it for years). Many traders not only lose money by trading choppy markets, but more importantly, they lose confidence. Since 80% of anything in life is psychology, protecting confidence should always be a top priority for traders.
6) I rarely short because I believe shorting is very difficult. In his Market Wizards interview, William O’Neil said: “I have only made significant profits on the short side of two of the last nine bear markets.” In other words, if one of the best traders of all-time finds the short side challenging, then who am I to try and re-invent the wheel?
7) The older I get, the more I like to focus on the QUALITY of my life. I like taking a “mental break” once in a while to make sure I’m not a slave to the stock market. I consider myself such an intense and aggressive trader during market uptrends, that I prefer to relax during corrective periods. Keep in mind that no one on their deathbed ever wished they worked more in life. They wish they spent more time with their families, spent more time traveling, etc. I have no problem with working hard, but I prefer to “work smart.”
Again, the simple answer to all this is: DO WHAT WORKS FOR YOU. Personally, I know my strengths and my weaknesses and I acknowledge what works for me. As I said in the beginning, I’m a trader and this strategy is not for everyone. Don’t get me wrong, I want the market to be healthy. I simply respect and understand that it’s not always going to go up. When it goes through corrections (as it inevitably does from time to time), I choose to sit out not only to protect my capital, but also to clear my head and protect my confidence. Remember, the market’s not going anywhere and there is more to life than trading.