Cool It

One of my kids' favorite books tells of a young, elementary school classroom hamster who over the summer has the chance to move to the country and plant his own vegetable garden. With the help of his new friend, a local bunny rabbit, they plant beans, lettuce, pumpkins, etc. The hamster can't wait for the plants to grow big, lush and delicious vegetables. Unfortunately he doesn't realize that growing a garden takes time, work and patience. He thought you plant the seeds, water the dirt and vegetables shoot out of the ground. When he comes to the realization that it's not an instant process he becomes very frustrated and emotional. His rabbit friend, having more experience in this area, tells him to COOL IT! Eventually with patience the garden grows, the vegetables are delicious and the hard work pays off.

I've been asked by many normal, passive investors over the last couple weeks about what they should do with their 401k's in light of this recent market volatility. There is notable fear present in market participants as many are remembering the dramatic effects of the 2008 Financial Crisis. 

What I've been telling them is to COOL IT! You're not always going to make money in the market. Something passive investors have not experienced over the past seven years is a stagnant or declining monthly statement balance. They have gotten comfortable with the concept of putting money in and it becoming worth more instantly. The market goes up, so my balances should continue to go up too, right?  This is easy!

The majority of millennials haven't been investing longer than 5-years. Either they were getting out of college during the recession or they have been paying off student loans with their extra savings. Now that they are working jobs that offer retirement savings they have become part of the passive investing class. They put money in every month and fortunately the market has cooperated nicely. The experience they have with savings and investing is that it always just goes up. But the moment they realize that prices can also go down, and do so rapidly, they get very nervous and want to sell. 

Investing is a process, just like a garden. It takes time and hard work. The results of this hard work will show themselves over time, but they will not happen instantly. There will be hiccups along the way; asset prices will fluctuate. 

Process matters more than short-term outcome. To be a successful investor you need to have a plan for how you will deal with certain scenarios that come along, because believe me, they will. These plans need to be decided outside the markets and especially not when your emotions are high due to near-term volatility in stock prices. 

One of the most important concepts an investor/trader needs to understand is their investing timeframe. This means both how active they will be with their investments and how long they have until they will need to use the money they have invested. If you have more than 10 years before you retire or need access to your funds, you should embrace short-term market volatility as it allows you to continue to purchase shares at lower prices. If you claim to be a long-term investor when markets are going higher, be a long-term investor when markets are going lower as well. Stick to the plan. 

If you choose to be more active with your investments then you will need market experience, rules, and a strict discipline to stick to your plan. Active investing is not easy and requires a lot of time to become functional. Managing your money isn't as simple as hearing about someone selling their shares and you deciding to also. If investing was as easy as selling when you "feel nervous" and then just getting back in when you "feel confident" then everyone would be rich. The market is a master of triggering your emotions at precisely the wrong time. It's designed to make you feel a certain way and make you react emotionally. Think about it this way, more money is dedicated to gaining profit out of the financial markets than any other avenue of venture. To think someone with no experience managing money or taking no time to understand market dynamics can just flip back and forth in their 401k's and be right every time, well you've got a rude awakening coming. 

If you want active management then you will need a plan for how you will respond to changes in the market. The basic conditions being that you want to be more aggressive when odds are in your favor and more defensive when they are not. You will need rules and guidelines that are tested to work over time that will alert you to how defensive or aggressive you need to be. These need to be direct reactions to market signals, not knee-jerk reactions to emotions or tips. 

With that in mind let's take a look at a couple longer-term guidelines I follow in determining my own active positioning. 

-SP500 positive or negative sloping 20 Week Moving Average

 When this indicator is positive my open risk will double on new trades or position adds. When it is negative my risk is cut in half.

Currently this indicator is in a decline and therefore suggests caution and smaller position sizes on new entries. Risk is elevated 

-SP500 weekly trend of higher highs/higher lows

When this indicator is positive the uptrend is intact and odds favor Long trades. When the indicator is negative odds favor defensive posture and Short trades are higher odds.

The trend suggests a new decline is potentially beginning. A higher high and higher low will be needed to reverse this. A reversal of trend will take time to establish. 

-SP500 position relative to the 20 Month Moving Average 

This indicator tends to protect against severe declining markets and position for strong rising markets.

As with any indicator, the results are not perfect. But generally following monthly closes above or below this moving average tend to keep you positioned for strong markets and avoid damage from severe corrections.

With one week to go until the close of the month of January, a Sell signal is likely to trigger from this long-term indicator. 

The important takeaway from this is that corrections and market fluctuations happen and are part of the normal cycle. Human emotions tend to be influenced by market gyrations. Unless you have a rock solid plan AND can execute that plan consistently your returns will suffer as your decisions will be based on emotional reactions and not market tested rules.

The current setup for stocks is that lower prices are likely. This doesn't mean we are going to crash like 2008 and we may have even seen the lows with this week's decline. All we can do is stick to our predetermined plans. Mine include taking action when certain criteria are triggered by the market. If your plan was to invest in your 401k for the next 10-20 years, then why are you reacting to a couple months worth of market gyration? That doesn't sound like sticking to the plan to me.

My best advice is to always stick to your plan and when you think about changing that plan after viewing your monthly statement...COOL IT! Your long-term goals will not be made or ruined by the next 6-months of market action. 

Thanks for reading
-ZT