http://www.thereformedbroker.com/2011/09/22/the-ten-crash-commandments/
1. Acknowledge that its a crash. Once we're past down 10% in the Dow Jones Industrial Average from wherever the peak was (yes, the Dow is a way better crash gauge than the S&P 500), you can stop saying correction and start saying crash. Better to be wrong in hindsight on the nomenclature.
2. Pencils Down! Whatever trendlines or individual stock research you were working on needs to be shelved for the moment. Your drawings and calculations will not work here. If you happen to buy a stock and it rips higher, it will not be because of your research, it will be because the market went up. Correlations always get jiggy in crashes, stocks become commoditized like bushels of wheat that must be liquidated regardless of the underlying businesses.
3. Don't listen to "stockpickers" or sell-side equity analysts. They are only looking out from within their own little bubble and they cannot comprehend the other little bubbles around them let alone the whole bathtub. Anyone covering specific stocks needs to know when the macro gyrations trump whatever earnings they've estimated or the conference calls they've listened to. There'll be a time to "know your stocks" but this ain't it.
4. Ignore the asset-gatherers and the brokerage firm strategists, their job is to calm markets and soothe investors. Let's say Morgan Stanley runs $1 trillion in stock market wealth for investors. And then let's say they felt there was serious trouble ahead. Do you really think they would ever make the sell call? Can Morgan Stanley really say "Sell 20% of your equities"? No. Because that would be $200 billion in supply hitting the stock market at once - they would crash it all by themselves! Too Big To Keep It Real has always been the problem with the wirehouse advice model.
5. Make sacrifices by reducing stock exposure by beta and volatility. This is my iron-clad rule. The moment you recognize the crash, kick the small caps, biotechs, emerging markets etc. You must separate your feelings for a particular asset class, sector or individual stock and recognize that the higher the volatility, the worse they're gonna act in the short-term. I have a prenuptial agreement with every position I put on and we get divorced cleanly in a crash situation if need be.
5a. Also, margin balances must get cleaned up immediately, take the losses, I don't care. Because broker-dealers and clearing firms can and will raise equity requirements right at the moment of maximum pain and force you to sell out later - and lower. I could tell you war stories you would not believe, kids.
6. Make two lists. The first list everyone knows about and talks about - the "if they get cheap enough I'll buy it at that price" shopping list. Fine, but don't forget the "things I will sell on the next bounce list". Even the worst markets have short-term bounces in the midst of the chaos, use these bounces to get rid of the things that make you ill on the red days, even if you're taking a loss. The stocks you bought on a flyer one day or the companies that have been disappointing or where the story has changed - sell 'em on the rips.
7. Watch sentiment more closely than technicals or fundamentals. Pay attention to the squishier things in a crash moreso than you would normally. Are people screaming in pain? Or are they still looking for a bottom? Or have they given up entirely? There is no math to this, a lot of it is "feel".
8. Abandon any hope or intention of catching the bottom. You won't and it is unnecessary. No one will carry you out on their shoulders if you manage to do it but you will definitely get carried out on a stretcher if you get it really wrong with your own capital. Keep in mind that time becomes more important than price...not where will it end but when?
9. Suspend disbelief. "Bank of America could NEVER be a $5 stock!" "How could Bear Stearns possibly go out of business, its a hundred-year-old firm!" "No way this stock should trade at 5 times earnings, it's a Dow component!" "How could the market go down 5% four days in a row?" Guys, anything can happen in a crash, there are machines making the trades and they have no respect for the prestige or standing of a particular company. This is both gut-wrenching to behold and great for the level-headed who eventually got to buy Wells Fargo in the teens or Apple in the$100s once the bottom was in.
10. Stop being a know-it-all and shut up. If you are telling people a price or a support line where the selling will end, you are only kidding yourself. Have a guess based on your discipline and research, but don't act like you're talking facts. Fair Value is fine, but call it a guideline. Support is also fine, but call it a historical estimate of where buyers have come in before. The deal with crashes is that extremes are the norm, not the exception. Things tend to overshoot through reversion to the mean trendlines or fair value estimates on their way back to stasis.
Anyway, I've been through a lot of these, and I promise you I'll find myself standing tall on the other side of this one. Following these rules will give you a shot at doing the same.
For many technical traders, finding the right technical setups (cross moving averages, technical shape) seem to be the most important component in a decision to put in a trade. But what is least emphasize has been another technical term: expectancy ratio.
It seems like a big word, but basically in layman term: let your winners run and cut your losses short.
Taking a very simple example of 10 trades, with a high 7 wins, 3losses and average dollars per trade as below, a trader lose -$200
| Trades | Win% | Lose% | Win$/trade | Loss$/trade | Overall |
|---|---|---|---|---|---|
| 10 | 7 | 3 | $100 | $300 | -$200 |
Reversing all the variables now, we can see from the table below, the trader with a small win-rate is still able to achieve $200 gain.
| Trades | Win% | Lose% | Win$/trade | Loss$/trade | Overall |
|---|---|---|---|---|---|
| 10 | 3 | 7 | $300 | $100 | +$200 |
Multiple above statistics a few hundreds to thousands trades, you will be able to see how important loss$/trade affect the performance of a portfolio.
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