Let’s for a few minutes make believe that this is the start of a deeper correction, one that’s inline with the average intra-year decline of the last 30 years which is 14%. Here are some of the things that you should know and do;
- If you are a trader you must reduce exposure.
- You should probably take some time off or reduce your activity and risk to a minimum.
- You must protect your confidence because BIG money is made after corrections, the deeper the better.
- If you are a trader then be a trader not a macro/news dissector tourist. You will only get yourself into a deep hole by trying to make sense of news, interest rate hikes, taper, etc…
- You should not short into the hole because rallies within deep corrections are the strongest.
- Buying breakouts is probably not your best bet, mean reversion trades normally work best in corrective markets.
- When doing mean reversion trades you should limit your universe to index etf’s, name brand companies, and or so the so called “LEADERS”.
- Most of the time corrective markets will get to every stock, even the ones that held up well.
- Normally the stocks or index that went down first will be the first to bounce once the correction is over-FIFO.
- The stocks that held up the best are the last ones to get hit, and once they finally get hit the correction is probably near an end–at least in the short term.
- Breadth indicators tend to be more useful in corrective/oversold markets.
- In oversold markets don’t dare short the first rip higher, wait at least 5 days.
- Sentiment usually is more useful in corrective markets.
- While mean reversion trades are great, remember when the flood gates open and oversold becomes more oversold you will realize that mean reversion trades eat like birds and shit like elephants. Look at the $SPY chart in August 2011 below.
- Try to understand why type of pullback/correction we are in—regular catch your breadth pullback or one in which a little emerging country tail wags the big dog. We get these every now and then.
- Understand that fear and or margin selling knows no support and overshooting is more the theme that plays out when we have a contagion type of pullback.
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