Investing & Online Trading – 7 Trading Approaches for Handling Current Volatility

In the late night business report on Tuesday we heard of the Chinese market's largest one-day fall in a decade (of 9 per cent) which had sparked the exodus of cash from global standards. The following morning we woke early and watched live on Bigcharts.com as the DOW quickly plummeted over 500 points to its low of the day before making a small recovery.

Later in the week a Sydney broker wrote in their morning newsletter:

"The market has suffered its biggest one-day fall in more than five years amid warnings of a 10 per cent correction in stock prices over the next month. yesterday in what market strategists described as the "correction we had to have" following stellar gains …… Strategists expect a correction of between 5 and 10 per cent over the next four weeks – similar to that in May and June last year – but emphasized the market's bull run was far from over because the fundamentals remained intact ..

…. Testifying before the House Budget Committee, Bernanke said Tuesday's sharp stock market drop had not changed the Fed's view that the US economy was sound. In addition, he said there did not seem to be any single trigger for the drop. But he added that investors may again have turned complacent as market corrections were never a one-day event and there could have been more selling to come. "

In our 'Investing and Online Trading' stock market newsletter and our own trading we do not make such predictions. Rather, we work on the balance of probability and prefer to decide in advance what we will do to respond to market and stock price action.

Those who have had funds invested in the market recently may be considered as one of the following seven groups:

1. Trader Contrarian – was bullishly buying while others around them headed for the exits. These traders were either gambling by trying to 'pick the bottom' to buy stocks 'for a bargain' on Wednesday or were actually acting on their buy signals, regardless of overall market sentiment.

2. Trader Warning Taker – heeded the caveations given by Daryl Guppy in recent weeks in his own newsletter 'Tutorials in Applied Technical Analysis' (Guppytraders.com) and as republished with his permission as his 'Guppy View of the Market' each week in our own newsletter – "The market has a tradition of market retreat in the late February to March period." Such readers may have:

Reduced the number of their open positions as their stops were progressively triggered or profit targets met, as per the examples shown in our notional Short Term Portfolio or

Placed conditional stops to sell if prices trigger tight intraday stops, as described in Max Lewis' ebook 'Conditional Order Trading Strategies' or

(For the more experienced) shorted the market prices or stocks early in the week, with the intent of making profits when the market fell.

3. Trader Early Bird – may have watched the US market overnight or before the ASX market opened on Wednesday – and chose to sell their positions at the opening price, using the techniques described in my 'Atkinson – Guppy Articles' ebook.

4. Trader Grapevine -may have heard about the falls later in the day and decided to add to the selling pressure during Wednesday.

5. Trader Stop Loss – may still be holding some positions because his / her initial or trailing stops have not yet been triggered eg they use weekly stops or hold stocks which are still rising or have yet to fall to trigger their end of day stops.

6. Investor Long Haul – may still be holding their stocks as they rationalize:

"I'm in it for the long haul 'or

"My broker says there will not be a crash because the fundamentals remain intact." Egypt

"How am I supposed to know when is the right time to sell?" Egypt

"I can not sell now – think of the tax I have to pay" or

"My broker says if the market goes down, I can buy some more at a cheaper price" or ………. or ……….. or …… …

7. Trader / Investor Frozen – may still be holding, even though his stops have been triggered.

With all best intentions, he / she planned where they would exit before they entered the trade and raised their stops as the trades went in their favor.

Then, when prices cavitated on Wednesday, they froze, like a deer blinded in the headlights of a car and switched into justification mode:

"I can not sell now – look at all the open profits I miss out on" or

"Prices can not keep falling – they've got to come back" or

"My broker says it's not a loss unless I sell it" or

"I've lost too much, so I can not sell it now" –

For those who do not know our story, my wife Angela and I speak from the experience of very hard knocks, having lost our own Sydney Harbor waterfront home in the tech stock rout of 2000 and beyond – with the ratione for holding on to falling prices at that time based on excuses such as those listed above.

We are more than qualified to share with you many of the pitfalls of the market. So we invite you to evaluate your own actions and reactions in the past week, as this may in turn help you:

Understand your own Emotional Management and, very importantly

Prepare you for the future, in case the next fall (s) is / are even more more than the last.

Are you thinking about the open profits which you've given back to the market or recent losses you may have made – are you looking at the real profits you may have banked in recent years and remembering yourself that the first rule of the market is to survive by protecting your trading capital?

All traders with experience know of the challenges that emotions can create in trading. Coming on March 15th 2007 is the first ever 'Guide for Emotional Management for Traders'. This guide was created specifically to give you specific steps to take so that you can trade in harmony with your feelings and have them be an asset rather than a liability.

In Edition 47 of our 'Investing and Online Trading' stock market newsletter, Dr Brett Steenbarger (www.Brettsteenbarger.com), author of 'The Psychology of Trading' (Wiley, 2003) and 'Enhancing Trader Performance' (Wiley 2006) provided This response to a letter from one of our readers, 'Trader Frozen':

"Hi Frozen,

Your problem is more common than you might realize. Many traders spend reasonable time figuring out when and how to enter the market, but put far less effort into determining exports and the amount of capital to risk on their trades. As you describe it, theitting of your stop losses is triggering a sense of regret.

That, in turn, produces a stream of thoughts regarding all the wonderful things that could have been done with the money lost. Such a pattern raises the distinct possibility for me that your stops and / or your position sizes are too extreme for your personal risk tolerance ……..

….. Because all traders are subject to risk of ruin, keeping position sizes aligned with holding periods and stops is essential to success. If you're trading large relative to your account size and you're worried about stops being hit, maybe you should worry.

My advice, Frozen, is to reduce your position size to the point where having your stops hit becomes no big deal.

When your stop is hit, you want to think, "That's OK; I can make this back." You do not want to feel like it's a calamity. If a string of five consecutive losing trades would knock you for a loop, financially or emotionally, you know you're trading too large.

All active traders often undergo such slumps, even the pros. It's tough to win at the game if you're knocked out of the game! "

Experienced traders understand the foundation of trading success is discipline.

There will always be opportunities available in the market – provided you look after your trading and emotional capital during corrections and survive long enough to trade another day.