In order to survive and thrive in ever changing market conditions, traders must adjust and adapt quickly. In just two short months, 2022 has quickly become one of the most volatile and treacherous market environments I have ever navigated. The VIX has spiked above 30, and we have seen virtually unprecedented volatility in various individual stocks ranging from Russian based companies like Yandex (Nasdaq:YNDX) to mega-cap tech names like Meta Platforms (formerly Facebook).
Unlike the market environment that existed exactly one year ago, the current environment is not one for newbies who lack effective risk management skills. It is also a dangerous market to regularly try to engage. Overtrading can prove to be very costly, both financially and emotionally.
Here are 11 things I have learned from trading in tumultuous market environments over the last three decades (including the 2007/2008 Global Financial Crisis, the 2010-2012 Eurozone debt crisis, and the February/March 2020 covid market meltdown):
You don’t have to trade. Despite the always present temptation to trade, sometimes the best move is no move at all. Being patient and waiting for market conditions to improve can oftentimes be the most effective choice. Taking a step back can also help us to clear our mind and work on improving our trade setups, our trading psychology, and our trade criteria. You don’t have to catch every market move or buy every stock that’s making 52-week highs. In fact, you simply can’t. Being ok with ‘missing out’ is critical to an optimal trading mindset.
Risk management is everything. Without effective risk management, it doesn’t matter how many great trade setups you find. The reality is you are going to have losing trades. And if you can’t manage your downside on the losers you won’t last long as a trader. Most novice traders tend to trade too large and average down as positions move against them. The unwillingness to just dump a losing position causes the trader to lose objectivity, and inevitably leads to account blow-ups.
Reduce your position sizing. Position sizing should be adjusted based upon market volatility; you shouldn’t be using the same position size when the VIX is at 30 as you did when it was at 15. The Average True Range (ATR) indicator is a good one to help gauge a stock’s volatility, but remember that ATR is a lagging indicator that won’t tell you what volatility will be in the future. It is best to respect the market’s potential volatility and err on the side of trading smaller.
Based upon my own trading and other traders I have observed over the years, there is an overwhelming tendency to trade too large. The bigger your positions, the less room for error you have. Moreover, during high volatility market conditions the trading ranges are often so large that the profits can still be enormous even with reducing your position sizing. The key is to catch a nice chunk of a few big moves while not getting stopped out just before the market whipsaws on you.
Hold more cash than normal. Cash may be trash most of the time, but during a volatile market environment cash provides flexibility and optionality. Cash is a position. Remember, declining asset prices offer opportunity to those with the cash available to buy at discounted prices. This is called optionality, but this optionality is only available to those with dry powder. In addition, cash offers the flexibility to take advantage of wider trading advantages and faster markets through short term tactical trading. During volatile market environments, there tends to be a lot of big overnight futures moves that lead to ‘gaps’ at the market open. Sometimes these gaps will be contrary to positions we are holding overnight. By going to cash and holding fewer positions overnight, we can sleep better and avoid nasty gap moves. This helps us to keep a clear head and maintain objectivity during the trading session.
Increase your focus by reducing noise. In 2022, we are confronted with a veritable firehose of news 24/7. The only way to handle this information deluge effectively is by curating our information intake and reducing our sources of information to a carefully selected handful. We have to decide what is really important to our trading methodology and ruthlessly cut out everything else. If we lose focus it will lead to suboptimal execution in a high speed trading environment. This will cost us money. At some point, you have to decide if you’re trading to make money or trading to be entertained. If you want to make money, your trading should be pretty boring and most of your time should be spent waiting for A+ setups to form and then executing them like a Navy Seal sniper.
Commit to spending at least one hour of your trading day moving your body and getting outside. Staring at monitors and not moving our bodies all day hinders our ability to achieve a high level of performance as a trader. Mindset is paramount, and having a healthy body is fundamental to having a healthy mindset.
Set realistic stop loss levels based upon market volatility and key technical levels, and respect your stops! If you don’t respect your stops you will end up suffering much bigger losses than you should, and your trading results will suffer over the long term. Remember, it’s not about being right, it's about making money. Taking losses is the price of playing the game; by managing our downside risk, we allow ourselves the opportunity to profit from the inevitable upside variance that we will eventually enjoy. One thing I have noticed over the years is that amateur traders regularly rationalize why they shouldn’t take a loss on a losing trade, whereas, professional traders are more than willing to quickly dump a losing position and move onto the next trade.
You don’t need to know what’s going to happen next. A lot of traders (especially newbies) think they need to have some grand thesis for how markets are going to play out in order to make money. Nothing could be further from the truth. In fact, during tumultuous market environments, it’s better to not be too opinionated so that we don’t get ‘stuck’ in losing positions for longer than necessary. It’s ok to say “I don’t know” and be ok with not needing to know what will happen next. Volatile markets often whipsaw multiple times, and each of these whipsaws offer tremendous trading opportunities to those who are flexible (both financially and mentally). Probably one of the worst feelings a trader can have is being fully invested as a volatile market moves against your positions.
Fundamentals don’t matter in the short term. Markets can do crazy things for short periods of time, and those crazy things can either lead to huge profits or huge losses depending upon how one is positioned. When I was new to the stock market, I spent years studying fundamental analysis; but when I wanted to be a profitable trader, I learned technical analysis. Technical analysis (TA) is priceless in volatile markets because it is the study of supply and demand in markets, and market prices move up and down based on supply and demand. TA can help us avoid making the big mistakes while occasionally identifying the juiciest trade setups. Above all, TA helps us to manage risk, not to predict the future with a crystal ball.
Never trade on margin! In volatile markets, margin debt (also known as leverage) kills! Some people will read these words and will still act like this doesn’t apply to them. They will inevitably have to learn the hard way, which may take multiple lessons involving account blow-ups before they get it through their thick skulls. Using margin debt to trade financial markets increases the likelihood that a market participant will become a victim of volatility. I’ve seen crazy things happen in markets. Owing your broker money because you purchased stocks on margin only increases the chances that one of these crazy market episodes is going to happen to you and result in the forced selling of your positions at the point of maximum pain. Jesse Livermore was the greatest market speculator of the first half of the 20th century. At one point during the Great Crash of 1929 he made $100 million (probably $5 billion in today’s money) on his short positions. However, not even Livermore could avoid the temptation of margin trading and he eventually went bankrupt five years later after betting too big during the depths of the 1930s bear market. In November 1940, Livermore was penniless and deeply depressed, ultimately taking his own life by shooting himself in the head in the cloakroom of The Sherry-Netherland hotel in Manhattan.
Greed kills. Margin kills. Just don’t do it.
The work included in this article is based on current events, technical charts, company news releases, and the author’s opinions. It may contain errors, and you shouldn’t make any investment decision based solely on what you read here. This publication contains forward-looking statements, including but not limited to comments regarding predictions and projections. Forward-looking statements address future events and conditions and therefore involve inherent risks and uncertainties. Actual results may differ materially from those currently anticipated in such statements. This publication is provided for informational and entertainment purposes only and is not a recommendation to buy or sell any security. Always thoroughly do your own due diligence and talk to a licensed investment adviser prior to making any investment decisions. Junior resource and biotechnology companies can easily lose 100% of their value so read company profiles on www.SEDARplus.ca for important risk disclosures. It’s your money and your responsibility.