The month of November definitely took an emotional toll on all investors including the professionals. Although we use a methodical approach via our trend lines and trailing sell stops, volatile markets at an inflection point can shake anybody’s confidence and/or conviction. An anonymous reader responded to last Saturday’s post as follows:
“It seems that it is always something unexpected that derails even the most powerful moves/bull in the market. They are always so obvious after the event happens. The subprime issues are like an octopus with 8 legs and no brain. Who knows what the other legs will be from the subprime head.
This latest 10% correction is probably just a signal that more is to come rather than the worst is over. Ned Davis has done some superb research over past corrections and once the market falls 10%, there is an equal chance that it will fall 15% from its highs.
Nassim Taleb has written a very good book “Fooled by Randomness” which really tells us that we will not know until it is over. Your work allows investors to be out during these tough times, and I am personally out of all but 1 domestic fund due to the fact that the others have violated 7% stops. The tough days are the last few when you are itching to get in emotionally, but statistically you must not.
Thanks for the work you do.”
This reader gets it. He has the emotional make-up to deal with market adversity, and he realizes that good times, such as we had during September and October, will undoubtedly followed by bad times. He is also aware that the markets currently are at a crossroads where a resumption of the existing up trend or a reversal towards bear market territory could be at even odds.
Reading books such as Nassim Taleb’s “Fooled by Randomness,” or “The Black Swan,” which I reviewed before, can help you get away from looking at markets with too much emotion but in a more factual way by accepting that tops and bottoms can’t be determined until after they have happened. That’s why sell stops fulfill the critical function of either locking in profits or limiting losses.
As of right now, it appears that October 31st was the high in the market. If you are reviewing your portfolio now, you might see a 5% or so drop off the highs, which should not upset you if you realize that one, you did well during the prior 2 months and two you enabled a protection mechanism that will prevent your portfolio from sliding into oblivion.
The overly eager actions by Treasury secretary Paulson, and the mortgage/banking industry as a whole, to hammer out an agreement by next Wednesday to freeze planned Subprime mortgage increases tells you that there is great urgency to stem the tide of foreclosures. At the same time, as I elaborated in Saturday’s post, banks and lending institutions are in dire straits because of their leveraged positions and shrinking balance sheets.
Again, the markets are at a crucial point. It’s imperative that you protect your portfolio from too much downside risk which means giving up some of your unrealized profits via your sell stops in order to avoid bigger losses. A bear market has become a distinct possibility although we won’t know it until we’re in the middle of it.