RealMoney Silver - Tips to Survive a Violent Market

Tips to Survive a Violent Market
By Daniel Dicker
TheStreet.com Contributor
1/24/2008 11:50 AM EST

Although I usually write columns with a bent toward oil and oil-related stocks, now would be a good time to put on my career hat as a commodity trader and tell you how I've been playing this market recently and how I suggest you do as well. I mean, stocks have been as violent and as vicious as any oil market I've seen in the past 25 years, so why not apply some of the knowledge I acquired over the years where and when it matters most?

To be "smart" in markets as violent as the one we're experiencing requires some special tools, but the most important of these will be calm thinking. One of the more costly pitfalls of not reacting calmly I see investors fall into is the trap of herd mentality. Professional traders do it all the time as well, so it's not something to beat yourself up about, but instead to be very aware of.

With the advent of cross-clearing between exchanges, electronic access and discount brokerages, the ability of investors, traders and institutions to entirely reshuffle their multimillion-dollar portfolios in a matter of moments has become far too easy.

When I was starting out in the business 30 years ago, changing tactics in a moving market was a long process of quotes, execution and confirmation that could last minutes. Now, we can do all three instantaneously with the click of a mouse. Even in my day of "two dollar brokerage," order execution could cost quite a bit. Today, discount brokers will fill any order for any amount of shares for less than $10, and some ECNs will pay you to provide liquidity.

This has given every participant the ability, if they choose, to move entirely out of stocks in the morning and be reinvested by the afternoon, virtually for pennies. That's been a major driver, in my view, of the intense momentum swings we've seen in this market and will continue to see.

With market volatilities at their highest levels ever, it is very easy to get "swayed by the tape" and move with the momentum trade of the day.

Here is my thesis for you to take to the stock market battleground: Momentum trading is for professionals. Don't pretend to be a professional.

If the market is down big and your portfolio is bleeding, every human's instinct is to get on the bandwagon and sell. Try to resist that urge. Conversely, on enormous up days in the market, you will be tempted to get greedy and look for follow through. Try to temper that feeling as well. If we can make the volatility and momentum excesses work for us as opposed to conspire against us, we'll have a better chance of navigating these choppy waters.

I know all of this sounds generalized, so let me tell you specifically what I have been doing.

Since becoming less enamored with the general market in November of last year, I cut my own portfolio allocation by almost 10% through December and put it back into cash.

Even with this reduction in stock exposure, I can tell you I also took quite a beating through the first three weeks of the year, as the rest of you have. Still, I have been pleased to have a nice percentage of investible cash on the sidelines ready to try to find some value in the market on extreme downdrafts. As of two days ago, I've been willing to put some of that cash back into the market.

I have some favorite stocks of my own, and I'm not sure that my choices for specific issues will be any better than yours. In general, I suggest large-cap, low-multiple value stocks, as opposed to small-cap or growth issues.

In addition, I'd advise you to steer clear of the sectors that have been pummeled the worst, although this idea might cut against your intuition. Wouldn't you want to buy an issue down 30%, as opposed to one down 15%? The answer is usually no. For example, large-cap staples have been relatively stronger in this downdraft and a candidate for buying. I own some commodity stocks, on the other hand, that I will be happy to liquidate on any reasonable bounce back.

And please, do liquidate some stocks on the up days, will you? Momentum moves that take money out of your account in whipsaw markets are equally overdone on the upside as the downside.

Finally, always keep something in reserve. I suggest having at least 5% of investible cash at the ready and 10% would be even better. For me, I would much rather have cash on the sidelines waiting to be invested at value prices and perhaps miss an opportunity or two than have all my money invested and watch a huge negative-momentum move sap a lot of open equity out of my accounts while having no "ammo" left in my gun to take advantage of a market aberration.

If we can accustom ourselves to the extreme volatility we are experiencing in the markets, we can take advantage of the opportunities created by these big swings instead of being a victim of them.

At the time of publication, Dicker had no positions in the stocks mentioned, but positions can change at any time.

Dan Dicker has been a floor trader at the New York Mercantile Exchange with more than 20 years' experience. He is a licensed commodities trade adviser. Dan's recognized energy market expertise includes active trading in crude oil, natural gas, unleaded gasoline and heating oil futures contracts; fundamental analysis including supply and demand statistics (DOE, EIA), CFTC trade reportage, volume and open interest; technical analysis including trend analysis, stochastics, Bollinger Bands, Elliot Wave theory, bar and tick charting and Japanese candlesticks; and trading expertise in outright, intermarket and intramarket spreads and cracks. Dan also designed and supervised the introduction of the new Nymex PJM electricity futures contract, launched in April 2003, which cleared more than 600,000 contracts last year alone. Its launch has been the basis of Nymex's resurgence in the clearing of power market contracts over the last three years. Dan Dicker has appeared as an energy analyst since 2002 with all the major financial news networks. He has lent his expertise in hundreds of live radio and television broadcasts as an analyst of the oil markets on CNBC, Bloomberg US and UK and CNNfn. Dan is the author of many energy articles published in Nymex and other trade journals. Dan obtained a bachelor of arts degrees from the State University of New York at Stony Brook in 1982.

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