Hey Rookie Bloggers! This week I am going to run a scenario by you that may seem somewhat familiar. This scenario can cause even the most disciplined trader to make a mistake. This scenario is one that typically comes along after the markets have had an extended run in either direction. When this scenario pops up there are a few things that can be done safely and we will discuss a couple of those things.
Here’s the scenario, you got a bunch of money sitting in your trading account, maybe you have had a few trades close and you got all this buying power that you want to put to work. So you do what every good trader does and you start combing through your watchlists looking for the next winning trade. Now, maybe you’re seeing that the indexes are pretty stretched towards the top. Maybe you have also noticed that the P/E ratios of the stocks are pushing towards the stratosphere. As you comb through your lists you notice that a lot of your favorite position stocks are at extreme valuations and not necessarily set up for a quality setup? What’s a trader to do? The most common reaction is to lower our standards and go in on a substandard trade. Of course, this is most often a mistake. I can think of three things to do that are better than putting on a substandard trade. So when you are looking for something to buy but nothing looks right then try the following tricks to see if it might produce better results.
- Do nothing! – this is by far the hardest but quite possibly the smartest thing to do. Sitting on one’s hands instead of taking a loss on a bad trade could be the difference between having a winning month versus a losing month. This takes rock-solid discipline and it often trips up traders. In the immortal words of Warren Buffett, “the stock market is designed to transfer money from the active to the patient.”
- Look Deeper! – If you are scouring your watchlists and not finding suitable candidates or setups then you may have to go further down the rabbit hole to find the best trades. This can mean doing market scans or searching out other trade ideas from quality sources like fellow traders or mentors or community sources like this one. Once you have found a trade idea you must do your full due diligence as there could be many differences between your usual trade setups and the ones you get from outside sources so it’s imperative that these setups fit your personal trading style. This is a far superior idea to putting on a trade that doesn’t make the grade, although may not be as sound as doing nothing at all.
- Sell Something! – If you are looking at the buy-side and everything seems out of reach or there is no right play to be had then taking the other side of the trade might just be what the doctor ordered. I have always found that selling something worked better when the buy-side seems inflated. When selling something we can change the nature of the winning trade. One can buy a call option and the trade only wins if the direction is spot on. This trade is bullish in nature as it requires upward movement in price. Selling a put option on the other hand is also bullish in nature because it benefits from a rise in price but it has several other advantages. Those advantages are that sideways and shallow pullback movement still get the job done.
The key takeaway from this scenario is that there are always other ways to think about a certain situation and if you can remain focused on the task at hand then one can usually turn the negative into a positive and still create opportunities.
Coach “Old Money” Holmes