Yesterday’s market action reminded investors once again that volatility has returned with a vengeance.
Investors pretty much got what they wanted yesterday with another 50-basis point interest rate cut. This comes after the Fed surprised markets last week by slashing rates 75-basis points. The Fed is on pace for its quickest monetary easing campaign since 1990… but investors reacted in a manic-depressive fashion that has become commonplace in recent weeks.
The Dow Jones Industrials rallied more than 200 points right after the Fed’s rate cut announcement yesterday afternoon, but gave it all back and 37 points more by the close. It’s impossible to say whether global markets will fall significantly further in the weeks and months ahead.
I’m extremely skeptical of anyone who tells me they’re “sure” stocks will continue to tumble OR that they’re “certain” a bottom is near. That kind of precision is reserved for engineers or scientists. Investors and traders on the other hand deal in a world of probabilities and possibilities – not certainties.
Step Back From the Market “Noise” and Evaluate Your Investment Goals
The key at times like this is to take a step back and carefully monitor unfolding market action from the relative safety of the sidelines. Now don’t get me wrong: I’m not advocating you should sell everything and go immediately to cash. That’s not a practical strategy for most investors. And as my colleague Eric Roseman has pointed out, it doesn’t make sense to sell now into an already oversold market.
There’s an old story (or perhaps it’s a tall-tale) that still circulates around Wall Street about the legendary J. P. Morgan (the Wall Street banker, not the Wall Street bank). During a bout of early 20th Century market volatility an investor asked Mr. Morgan what he should do, because sharp stock market swings were keeping him awake nights. Morgan is said to have replied: “you should sell down to your sleeping point.”
Depending on whether you’re a short-term trader, or a longer term investor, you must find your own particular comfort zone (your “sleeping point”).
Are You an Investor…
As an investor, with a “time-horizon” of months to years, you should stay focused on the really big macro trends unfolding in the world. Don’t let short term market “noise” unduly influence you. It’s not about what happens to gold, Hong Kong shares, or the U.S. dollar next week, or next months. It’s about where the world is headed over the next five-years that’s important.
If you told yourself “I’m in this for the long-haul”, but now feel uncomfortable, welcome to the club. Adopting a long-term view in today’s globally integrated financial markets ain’t easy – especially with Cramer (and so many others) ranting and raving at you from the idiot-tube. Turn it off, and double-check your facts instead.
Now is a great time to “check the story” as Fidelity’s Peter Lynch used to say. Re-examine the fundamental reasons why you own the investments you now hold. If the story has changed for the worse – the compelling reasons for buying are no longer there – then perhaps it is time to sell.
In other words, look at each of your current holdings and ask yourself this simple question: “would I make this investment again today?” Be as objective as possible when answering, but if the answer is “no”, then it’s definitely time to move on and raise some cash.
…Or Are You a Trader
Traders by contrast, typically have a shorter-term perspective (time horizon of weeks to months), and should never get “married” to a particular position or story. Good traders are skilled at playing both sides of the market – occasionally at the very same time (this is called hedging).
If you’re a trader, now is the time to pay close attention to the signals the market sends out. You’re focused on sentiment – which drives share prices in the short run – more than by long term fundamentals.
As a trader your risk management is at least as important (perhaps more so) than your timing in correctly identifying a trend. Stop losses, money management, position sizing – this is the critical gear in your traders’ tool-box.
You are playing the probabilities, based on imperfect knowledge and your own interpretation. This realm has no place for “certainties.” Expect to be wrong, perhaps more than you’re right. But be prepared to quickly admit when you are wrong, cut your losses, and move on to the next best trade with a high “probability” of success.
Which ever camp you find yourself in; "investor" or "trader" it's gut-check time. Make sure your strategy stays on course in this volatile market, and stay alert for the next big move.
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