These days it seems as if the stock market never enjoys a nice, leisurely – and healthy – pullback. There was a time when that was the norm for the stock market, when after a strong run in a bull market it was expected that the indexes and the stocks that make them up would “come back in” a bit.
Investors and traders who wanted to book some profits would trim their holdings and that selling would cause the market to drop. But the buying and selling was more controlled, more restrained, less volatile and more orderly.
Those were the days when people, actual people, not computers, would be responsible for executing orders, but that time is long past. Millions of shares can trade in the blink of an eye thanks to technology, something that is good for liquidity, but can be bad for your nerves.
Nowadays markets don’t pullback anymore as much as “crash.” We’re not talking about a crash in the traditional sense – famous examples being The Crash of 1929 or Black Monday in 1987 – but mini version of those events, similar in their volatility, if not their size. And just like their larger cousins, these mini-crashes can be unsettling to the average investor; however they should instead be looked at as opportunities.
Being successful in the stock market is all about knowing which stocks are in favor, and will continue to be, and which are out of favor, or are about to be. Watching what happens to individual stocks during these mini-crashes can often signal who the leaders will be when the market stabilizes and makes its next move up.
The trick is to watch the relative strength to see which stocks sell off the least in comparison to the broader market, and to have enough dry powder to allocate to those stronger stocks. You get that dry powder by trimming your losers when the stock market begins to show weakness. This is one of the major advantages of using technical analysis in your trading and investing.
Technical analysis provides you with objective criteria in the form of indicators which can help signal when weakness is showing up in the broad market and can show you which of your holdings you should sell in order to raise cash.
As the market is going through its mini-crash the first thing you want to look at is which sectors are holding up better than the broad market. For example, if the broad market is off 12%, but the Technology sector is only of 6%, then that sector is showing 50% more relative strength than the market as a whole. This indicates that the stocks that make up that sector are in “strong hands,” meaning institutional investors who are not willing to sell.
The next thing to do is to look at the individual stocks that make up that sector to see which ones are showing better relative strength than the sector itself. This top down analysis is designed to identify the stocks that have the best chance of outperformance when the market turns around. These are the stocks you want to put new money to work in.
It is important to note that indiscriminately buying stocks just because the market drops is a dangerous game. What I am describing here is a very analytic, unemotional, and structured methodology for buying stocks in a down market. And if done right, over time it can improve your returns and add to your bottom line by making sure you are always investing in the market leaders.