There are so many jittery traders out there, worried about a market pullback. A pullback is perfectly normal and healthy, so don’t let one scare you. If you are scared, you’ll look for any excuse in the book to sell. You want to avoid being the last one out the door before it slams shut, which means you’ll be desperate to time your exit perfectly so you can remove yourself unscathed.
And therein lies the trick: Timing the market is truly an exercise in futility. It’s a guessing game that requires luck to be successful. While luck is sometimes needed in trading, you don’t want to rely upon it. Instead, you want probabilities to stack up in favor your favor.
How to prepare for a market pullback
Luck is what happens when preparation meets opportunity. So, how do you prepare for a market pullback and find opportunities that will benefit you – or protect you?
As an options trader, you are in the moving business, and not the storage business. If you are constantly moving capital around, selling when you have profits, cutting losers, and holding lots of cash at all times, the little surprises that come around (tweets out of left field or news from China or Europe that puts buyers in a foul mood) won’t hurt you too badly.
You also need to be aware of your own mood, which tends to dominate your actions. Ever found yourself on the wrong side of a market trend, wondering what you were thinking? Sure you have; we have all been there at some point. The key challenge is changing that behavior and accepting that markets fluctuate. Again, if you are in the moving business, your portfolio will be OK.
Markets don’t go up every day forever, but when the market trend is unchanged for an extended period of time (like this current bull trend), traders are lulled into complacency. You’ll see this in indicators such as the VIX, put/call ratio and TRIN. You’ll also see it when oscillators are overbought, the indices are stretched further than the moving averages, or when volume trends retreat as the markets rise (divergences). These are all signs that a market pullback is likely to come, but it does not necessarily mean there’ll be a change in the big picture trend.
The most important reason to be prepared for a market pullback? It’s a great opportunity to pick up stocks on the cheap so you can continue to build wealth during a rising market trend.
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