In light of October’s bloody departure, a pivot is in order for today’s edition of ‘The Month That Was” series. I’m hopeful it will be a bullish pivot sending my commentary along an upward trajectory.
Rather than follow the usual format I’ve compiled a list of lessons that we all should have learned (or re-learned) from the crash. The market provided the tricks; I’m providing the intellectual treats.
Number One: Harvest Gains, Plant Elsewhere
Though Lady Luck left me naked and alone for much of the month, she did smile upon me in one regard. My primary active trading account sat in cash before the downturn and was thus insulated from any losses. It wasn’t because of any well-time premonitions, mind you. Rather it was because I needed the capital for another venture. And while some could say the fortuitous timing amounts to luck and nothing more, it does illustrate a very powerful investing concept.
There are two ways you can go about growing your dough. First, you can keep it in the same account and allow it to compound. Over time the dollars gained and lost per trade will increase. That is, the fluctuations will increase commensurate with the account size. When your account is $10k, the typical loss may be $100 while the average gain is $200. But when the account rises to $100k they move toward $1,000 and $2,000. Though your trading plan may be identical the dollar fluctuations you must tolerate went up 10x.
The alternate idea offers a more diversified approach. Rather than continually compounding in the same account, what if we raked off the gains every year and planted them to grow elsewhere? The variations on this theme are endless, but one example might be taking the profits from trading and moving them into real estate or commodities or some other business venture. In doing so, you will halt the compounding in your trading account, but allow those greenbacks to grow elsewhere.
Then when crashes or bear markets strike in stock land, you won’t be as exposed.
Number Two: Bruised, but Not Broken
Risk is inextricably linked to control. Where no control equals tons of risk, and complete control equals minimal risk. Sidestepping drawdowns (the loss of capital) is impossible but never forget you control their magnitude. It’s all about position sizing, or the number of shares/contracts you have in the trade. Traders that came into October toting a portfolio bursting at the seams with bullish positions were carried out in body bags. Conversely, those who took a more calculated amount of risk were able to exit the month bruised, but not broken.
In winning months we all wish we had more exposure. In losing months, we all wish we had less. Ensuring your survival and longevity is all about striking the right balance between the two.
Number Three: Danger Lurks at Turning Points
No one but liars and lucky ducks make money all the way up and all the way down. And those rare ducks always run out of luck. The reason for this is because if you’re trading with the trend then you are necessarily bullish at market tops and thus vulnerable when the rug is suddenly pulled from beneath. Sure, you can then turn bearish but on the initial reversal from uptrend to downtrend you are at the mercy of the market.
I never feel bad taking a hit when an uptrend rudely reverses. Now, if I continue to get pummelled because I fight a newly established downtrend all along the way, then that’s on me.
The same can be said when a downtrend reverses higher.
