Investing has more than a few quirks that make it like no other endeavor out there. However, what’s not unique about this discipline is that preparation is paramount to success.
What can be frustrating is that sometimes the market is sparse of worthwhile opportunities. It’s not all that uncommon for professionals to find themselves lunging into trades that they otherwise wouldn’t chase after, simply because they feel a need to be doing something.
The problem is that more often than not — and especially during periods of high-volatility when many are inclined to rush for the exit — the best thing to do is absolutely nothing.
In fact, most long-term investors would be better served not worrying about hedging strategies during event risk situations due to high costs and market timing risk. Read more about the three most common hedging mistakes you should avoid.
If the market is lacking opportunities that fall in your comfort zone, that’s OK. Just wait. You don’t need to overcompensate or overtrade. Instead, consider three actionable, non-trading, research-oriented ideas:
1. Look for Sector Rotation
Pullbacks are a normal part of the stock market cycle, and it is during these periods that sector industry leadership often changes — although we can only know this in hindsight. Every meaningful sell-off that doesn’t transpire into a full-blown bear market is typically a period during which many institutions reposition their portfolios, thereby setting the tone for the next wave of leaders and laggards and giving meaning to the term “rotation.”
The simplest ways to go about identifying sector rotation is to:
- Review the 1-year, 6-month, 3-month, and 1-month performance of all sectors leading up to the most recent peak. You can view the SPDRs select sector tracker here. Who are the most consistent leaders? Why?
- Review the performance of all the sectors spanning the date range of the sell-off, from peak to trough. Take note of any sectors that were surprisingly resilient and plunged a lot less, as they are likely to be leaders once the broad market recovers. However, this is not always the case, as seen with consumer staples and utilities, which often fall less during corrections given their low-beta profile, but then proceed to lag in the subsequent rebound.
- If there is an event related to the sell-off, such as a change in Fed policy or a geopolitical shock, then you have to dig deeper and see which sectors are fundamentally most and least exposed to the said catalyst.
It is up to you to distinguish which pullbacks have more interesting activity brewing under the surface when the major indexes are falling. By standing back and observing the market during pullbacks in lieu of trying to chase it, we can see where the next set of opportunities may emerge and be ready when the reversal is confirmed.
2. Review Your Rebalance Plan
This is really another way of saying: Review your long-term goals before doing anything in your portfolio.
Before you look to put new capital to work, consider pruning and/or rebalancing your current positions first. There is arguably no more productive activity than reviewing your own strategy, as it subconsciously reinforces discipline and patience — two keys to success over the long haul.
3. Start and/or Update Your Trading Journal
The benefits of keeping a trading journal, even if you are not a trader per se, are tremendous. For starters, you are forced to write down your thesis/case for what you do. This action should automatically reinforce the habit of asking yourself whether or not any given trade aligns with your long-term goals as highlighted above. You will be surprised how many reactionary trade ideas this simple action alone will filter out for you.
In addition to keeping track of the obvious information, such as buy price, quantity, sell price, profit/loss percentage, etc., in your trading journal, consider adding some more qualitative columns, such as:
- Buy reasons (fill out before the trade)
- Sell plan (fill out before the trade)
- Sell reasons (fill out after the trade)
- Lessons (i.e., what could be improved; fill out after the trade)
The Bottom Line
The next time you have an urge to do something in your portfolio, stop and consider if you’re chasing after a position outside your comfort zone. There’s no need to be active all the time. Consider the three ideas outlined above as a starting point for your research the next time the market is lacking in tradeable opportunities.
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