Since the end of September, the stock market has been undergoing some of the worst corrective action in a very long time. We saw some sharp dips back in February and March but the recovery was quick and the pain of the pullback did not linger.
The current correction has been much more grueling, not only because of the intensity of the selling, but because it has now lasted more than six weeks and there is no sign that it is about to end. Support levels have fallen, downside momentum is strong and any strength is being sold.
Despite the generally poor action there are some signs that some stocks are looking to find support. Groups such as semiconductors and biotechnology are looking washed out, although it is hidden by accelerated selling in other groups like retail and the FAANG names.
As this corrective action plays out the best thing you can do is put together a shopping list and start tracking stocks of interest. They may be names with good numbers or an interesting story that have been caught in the selling maelstrom which doesn’t distinguish “good” stocks from “bad.”
The big question to contemplate is how do you enter these stocks that you believe will outperform when the market finally finds its footing and turns back up? Here are the key steps:
- Don’t buy into the teeth of a decline. When a stock is in freefall it can be very tempting to try to catch it as it drops sharply. While you may get lucky and time an entry just right, the problem is that this approach does not make for easy risk management.
- It is better to buy only after a stock makes a positive move. Psychologically this can be difficult for some market players because they believe that catching the absolute bottom tick is the hallmark of a great trader. That is not true. The goal should be to buy when there is the best chance of a trend.
- When you buy a stock only after it bounces, the recent lows will be the natural support level. It may not be strong support but there will be a level there that allows you to employ a strategy to manage risk. You may want to use it to add further to a position or maybe you will use it as a stop out point.
- The most important thing when you bottom fish for a stock is that you do not let it turn into a long-term investment if it doesn’t work as planned. If the trade doesn’t work, take your loss and move on.
- Make sure you have clarity of time frame. The biggest bounces occur in the worst markets. If you are trying to catch one then your time frame will have to be very short. If you are looking for longer-term holds then you better be prepared to deal with a high level of volatility as the market struggles to regain its uptrend.
So, while this market action is some of the worst we have seen in a long time, the good news is that it will lead to some great opportunities. Finding entry points and managing the trade is key. As long as you are aggressive in managing your risk, you will be able to navigate any market.