Check the Checklist

by Jay Pestrichelli on March 18th, 2013

Everyone is pontificating about if or when the current bull market is going to correct. Market timing isn’t something we like to do very often and I’m going to stick to that. But we do follow a disciplined investing approach and so we thought we’d take this opportunity to remind you of the recommended Checklist we have posted on our resource page.

The list is as follows:
  1. Review global or sector bias
  2. Choose the Investment
  3. Review the diversification exposure
  4. Choose the trade and hedging tactic
  5. Calculate your Capital at Risk tolerance
  6. Set investment Size
  7. Check remaining risk
  8. Harvest as necessary / Ongoing management
 
This mix of steps deliberately covers both the rationale and mechanics of entering and watching over a position. We do this to keep the tick-by-tick action of the market connected to the underlying thesis of why the trade was considered in the first place. Today, we’re going to focus on steps 1 and 8.
 
Reviewing global or sector bias
Watching the current run up has everyone wondering when the turn is going to come, but the real question you should be asking yourself is “Has anything has changed to the bull case?” Back in early January, the case for the bulls was mildly stronger than the bears at the time. The worry about earnings and the upcoming government spending sequester were close at hand and today those have been essentially discounted out of the market. They still exist, but seem to have had no impact on stocks…yet.
 
If anything, the bull case has been made stronger. Acceptable unemployment data, strong housing data, and even industrial production have all provided more fuel for the bull run. Add to that halo effect of the seemingly never ending QE program and anyone who bought in January has more reason to buy in March.
 
The bears will tell you the technicals are showing signs of a top.  Some momentum indicators like the daily RSI or CCI show a mildly overbought status for the Russell and the S&P 500. The Dow Jones Industrial averages is, however, looking overbought, but remember it’s only 30 stocks, so probably not the best barometer for the broad markets.  Overall, the bear case is weak except for the popular mob opinion of “It can’t go up forever”
 
I’m not making a bull case here, but just reminding everyone that the reasons for a change in direction have not made themself evident yet.
 
Harvest as necessary / Ongoing management
Harvesting gains is always more enjoyable than harvesting losses; except for times like April 15th when we have to pay the taxman for them. If you’ve been in this market, as we have, you’re probably asking yourself the best way to lock in some of these gains and the signals for when it will be time to get out. As readers of this blog you know we always recommend hedging your positions and watch signals like the price of the VIX or the Cost of Hedging to help us determine how to best manage that cost.  This continues to hold true.
 
So I’ll go out on a limb and say that even more important than knowing when the market is going to turn, is having a plan in place for when it does. I had a dream the other night that we had another flash crash and I relived those 20 minutes when I watched the Dow drop from down 300 to down 900. However, this time in my dream, instead of scrambling to evaluate my current positions like I did on May 6th 2010, I was scrambling because I had not figure out what I wanted to buy on the dip.  See even in my dream I knew I was hedged and wasn’t worried about my losses because they were already defined. Instead my anxiety was more about how I had not prepared my rotation or speculative trade. (I realize how sad and pathetic it is that my anxiety dreams involve watching a trading platform)
 
If you’re prepared for the dip everyone is waiting for, it means that you can focus on what’s coming next. If in your opinion an occurring selloff is justified, have your bear plays prepared. Looks for those asset classes/sectors/stocks that will suffer the most and be the first one in (it’s always best to be the first in in case you didn’t know). If the reason why the dip came had nothing to do with anything real (like an Italian election sell off on 2/25…come one), then have your list ready for what you’re going to cherry pick. Use that inner guru of yours to be prepared for opportunity.
 
I’ll close with one of my favorite sayings: “Success can be found at the intersection of opportunity and preparation”


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