How to Play Stock Market Selloffs and Monster Rallies

The market is notorious for behaving in cycles.

As the saying goes “history repeats itself.” Maybe that’s why as the years progress I become a more patient trader.

When the market sees a big selloff it’s a great time take a step back and look at your portfolio and the big picture.

Step 1: Do Nothing

Why? Usually our first reactions (at least when it comes to trading) are irrational, because they’re based on emotion. Thus, impatient traders are inclined to sell all of their investments and move to cash. Did you catch the disconnect there? Letting a short-term emotional reaction influence our long-term strategic approach

When we look at the markets on a day to day basis we can get caught up in the emotional strain from a big down day and immediately go into fight or flight mode. People often forget that these down turns are healthy for the markets. They build strength and enforce the structure of the up trend over the long run.

Pull out to a 10 or 20 year chart. The selloff doesn’t look so big anymore does it?

How to Trade Volatile Markets

The importance of separate accounts (short-term trading versus long-term investing) is so critical in these market conditions. It makes the profit and loss clearer and acts as an emotional barrier between the two mindsets.

Rather than trying to take capitalize off the daily swings that occur after a steep decline my approach is to turn to the small time frame of the 512 tick chart. I prefer this method in wild times because it keeps me objective and doesn’t allow me to over-commit to a bias or opinion I may have about where the market might be going.

See when the market volatility increases, the daily ranges increase, thus providing more profit potential between your entry and target. A tick chart is made up of # of trades (in this case 512) rather than time, so you get a lot more movement in these volatile conditions, but because you’re on the smaller time frame, your stops can remain small.

In Summary

Don’t panic. Don’t sell all of your investments. And be prepared for some monster up days amidst even the biggest freakish selloffs. Look to the market internals to help guide you in these wild times and most importantly, don’t loose sight of your long-term goals.

Remember the 2009 selloff? We’re certainly much higher now that we were before. Continuing to add to your dividend paying investments throughout a decline will insure you’ll be better off when we come out the other side.

An in-depth look at a few concepts from this article:

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About Tim Racette

Tim is a full-time trader in the futures and stock markets and founder of EminiMind.com. He is also a Chicago-land native, competitive mountain biker, adventurer, and ASU Sun Devil.

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