Option Investor
Educational Article

Surviving a Sideways Market

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By David Popper

For weeks, I have talked about the need to eliminate emotion from trading. I confess to you that my trading goes from good/adequate (meeting my goals) to poor when emotions invade my thinking.

Over the past several weeks, I have discussed possible "systems" that can be utilized in sideways markets to reduce emotions and thus, increase your chances of success. Now, I would like to review several of these items:

1. In a sideways market set reasonable goals for each account based on time parameters and based on market conditions. Is your goal cash flow on a monthly basis or, alternatively, is it long term accumulation? Long term accumulation is a much easier goal to attain. Time can make up for many mistakes. Trading for monthly cash flow in a sideways market requires much more acumen. I would suggest initially that your monthly goal should be broken into twelve mini goals. I realize that there are twenty trading days in a month, but some days stocks just won't cooperate. It is unreasonable to think that you can win every day in a sideways market, so shoot for 60%. I would suggest that once your mini goal on any day is met, the trade should be exited unless there is a darn good reason for you to remain in the trade. Nothing is more disheartening than attaining your goal, yet staying in the play because there is a chance for a big hit, only to see your profit dissolved.

2. In a sideways market trade only stocks that are leading stocks in leading sectors of the economy. When you only trade leaders, a great deal of pressure is removed. If, for some reason, you make a mistake and are left holding the stock--it is still a great stock. Avoid trading stocks that you would not like to own, no matter how good the chart looks at the time. If you are trading only great stocks and the stock takes an unexpected turn and you fail to exit properly, the chances are excellent that the stock will eventually return and place you in a profitable position.

3. In a sideways market trade only a small amount of stock. A small amount of stock can easily help you reach your short term goals. For example, I have traded PMCS over the past month and have managed about a $500 profit per day. This stock is rated either a "buy" or "strong buy" by nearly every analyst and is considered one of the strongest stocks in its sector. The stock has a high relative strength and technically is in a trading range between $140 and $190. This stock maintains a great deal of volatility and typically will trade in a range of twelve to twenty points per day.

4. Pay attention to events affecting your stock. Events such as earnings, splits, analyst meetings, and participation in conferences can affect your stock. Additionally, news on other stocks within the sector will have an impact on the stock you are trading.

5. Have a plan if things go south. Many people enter a trade without considering the potential downside of such a trade. There are a myriad of books that discuss when to sell stocks, including many advertised on this website. Personally, since I am trading a small amount of stock within a well defined trading range, I typically will sell the stock only when it breaches the trading range on the downside for more than a day. At that point, I feel that the stock can no longer be trusted and perhaps there may be a fundamental problem with this stock. It may have changed from being a leading stock to a has-been. Before making this decision, however, I will look at the sector and the market as a whole to determine whether this stock is trading in sympathy with the larger forces or whether it is suffering for its own sins. In any event, I have a lot of leeway because I am only trading a small amount of stock.

In short, if you can follow these above rules, you will have designed a system which should be profitable and which should usually protect you from any devastating loss. Living within such a system should increase your confidence and allow you to trade with much less emotion.

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