What is the right strategy in this highly volatile market?

As the market is struggling to find the bottom, the volatility is quickly rising. This is typical in a bear market, in which a significant rally occurs from time to time, but every time after such rally occurs, another new low follows.  To a trader, this is the toughest market environment since it’s directionless; to an investor, this is the perfect time to demonstrate your discipline.

Strategy I: only buy stocks you’ve fully analzed and well thought out.

Bear market provides more value opportunities. Investor can slso afford to take time to think through all the variables that would affect an investment. If you still regret any investment decision after you make a purchase, you can blame no one but yourself.

Strategy II: be realistic about absolute downside risk

Many investors are capable of doing fundamental analysis and getting pretty good sense what risk/reward for a stock is – in a normal environment. However, in an extremely uncertain environment, such as recession, war, famine, finanical crisis, etc., theoretical downside is more likely just theoretical. The real trading downside risk could be much lower.

A long term investor who has more than 18-24 months’ time horizon might not care too much about this. However, most individual investors and most professional investors do care – for different reasons, though. Individual investors have limited capital so preservation of capital is the most important; on the other hand, professional investors have performance pressure.

 As a result, getting absolute downside risk right is very important. How to do it? Stress test. Every single investment should be tested in an extremely adverse scenario to get an honest assessment of real downside. By doing so, you should be able to avoid many costly mistakes. More importantly, you might be able to pick winning ideas even in a down market if the stock trades at close to the level you’ve quantified as “absolutely” low. 

 Strategy III: no catalyst, no buy.

Many stocks are probably trading close to their intrinsic value or even at discount by now after the recent correction. However, many are not good buys – yet. If simply buying because they’re cheap, you’re either truly “long term” investors, or just speculating on a macro or sentiment recovery sooner than later. I doubt many of you are really in the first camp.

Therefore, catalysts are important to be identified before a real purchase. They could include good .earnings for the current and next few quarters despite macro concerns (but you have to be very confident), corporate events that could have positive implications (spin-off, recapitalization, new product announcement, etc.) and others. Need to be aware of negative catalysts, too.

Strategy IV: Cash is king.

There is no reason to force yourself to buy if you can’t find any reasonable picks. Cash is still producing low single digit return, which is better than negative market return that is likely to stay for the next several quarters. 

In the end, bear market is no different than a bull market to a value investor. Control your temper, calm down and do your work. Only buy after you get full conviction. Treat every single investment as a business decision – a serious businessman will not allow even one money-losing failure. Treat evey stock invesment as buying a fractional ownership of a business, not just a piece of stock certificate.


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