August 30th, 2011 12:29 EST
You Can Make Stock Market Volatility Your Very Best Friend
Most people never forget their first love. I`ll never forget my first trading profit --- but the 600 1970 dollars I pocketed on Royal Dutch Petroleum was not nearly as significant as the conceptual realization it signaled.
I was amazed that someone would pay me that much more for my stock than the newspaper said it was worth just weeks ago. What had changed? What had happened to make the stock go up, and why had it been down in the first place? Without ever needing to know the answers, I`ve been trading RDSA for over 40 years!
Looking at scores of similarly profitable, high quality companies in this manner, you would find that: 1) most move up and down regularly (if not predictably) with an upward long-term bias, and 2) that there is little if any similarity in the timing of the movements between the stocks themselves.
This is the "volatility" that most people fear and that Wall Street loves them to fear. It can be narrowly confined to certain sectors, or much broader, encompassing practically everything. The broader it becomes, the more likely it is to be categorized as either a rally or a correction.
Most years will feature one or two of each. This is the natural condition of things in the stock market, Mother Nature, Inc. if you will. Don`t take her for granted when she gets high, and never ignore her when she feels low. Embrace her volatile moods, work with them in whatever direction they travel, and she will become your love as well.
Ironically, it is this natural volatility (caused by hundreds of variables human, economic, political, natural, etc.) that is the only real "certainty" existent in the financial markets. And, as absurd as this may sound until you experience the reality of it all, it is this one and only certainty that makes Mutual Funds in general (and Index Funds in particular) totally unsuitable as investment vehicles for anyone within seven to ten years of retirement!
How many Mutual Fund investors have retired recently with more liquid financial assets than they had 12 years ago, way back in 1999? There will always be rallies and corrections. In fact, it is worthwhile to "go back to the future" to establish a realistic long term investment strategy.
In the last forty years, there have been no less than ten 20% or greater corrections followed by rallies that brought the market to significantly higher levels. The DJIA peaked at 2700 before its record 40% crash in 1987. But at 1700, it was still 70% above the 1000 barrier that it danced around with for decades before --- always a higher high, rarely a lower low.
The `87 debacle was followed by several slightly less exciting corrections, but the case was being made for the more flexible, and realistic, Market Cycle Investment Management Methodology. Modern Portfolio Theory was spawned by great minds selling future predicting snake oil; Mother Nature, Inc. is a much too complicated enterprise, even for them.
Call it foresight, or hindsight if you want to be argumentative, but a long-term view of the investment process eliminates the guesswork and points pretty clearly toward a trading mentality that keys on the natural volatility of hundreds of Investment Grade Value Stocks (Google IGVSI).
During corrections, consider these simple truths: 1) although there are more sellers than buyers, the buyers intend to make money on their purchases; 2) so long as everything is down, don`t worry so much about the price of individual holdings; 3) fast and steep corrections are better than the slow attrition variety; 4) always accept even half your normal profit target while buying opportunities are plentiful; 5) don`t be in a rush to fill your portfolio, and if cash dries up before it`s over, you are managing the process correctly.
Most of the problems with Mutual Funds and much of the increased opportunity in individual stock trading are functions of growing non-professional equity ownership. Everyone is in the stock market these days whether they like it or not, and when the media fans the emotions of the masses, the masses create volatility that rarely under-reacts to market conditions.
Rarely will unit owners take profits, particularly if they have to pay withdrawal penalties or taxes. Even more unusual are expert advisors who encourage investors to move into the markets when prices are falling. A volatile market creates opportunities with every gyration, but you have to be willing to transact to reap the benefits.
A necessary first step is to recognize that both "up" and "down" markets are forces of nature with abundant potential. The proper attitude toward the latter, will make you much more appreciative of the former.
Most investment strategies require answers to unanswerable questions, in an effort to be in the right place at the right time. Indecisiveness doesn`t cut it with Mamma --- in or out too soon is not an issue with her. But wasting the opportunities she provides really ticks her off.
Successful investment strategies require an understanding of the forces of stock market nature, and disciplined rules of portfolio management. If you can transition back to individual securities, you will do better at moving toward your goals, most of the time, because the opportunities are out there --- all of the time.
So let`s adopt some new rules for this investment game and learn to live with them for a few cycles: Let`s buy IGVSI stocks new and old at lower prices during corrections. Let`s take reasonable profits on those that go up in price, whenever they are kind enough to do so.
Let`s examine our performance based on the results of these trading transactions alone and at market cycle examination points for a smiley faced change of pace. And one other thing:
Let`s drink a toast to an uncertain and volatile Mother Nature, and, of course, to our first loves.
Ask Your Financial Professional About Market Cycle Investment Management.
Author of "The Brainwashing of the American Investor: The Book That Wall Street Does Not Want You To Read" http://marketcycleinvestmentmanagement.com