In a Bear Market, Think Like Ted Williams
Traders consistently make this big mistake as they try to take advantage of bargain prices in a poor market.
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Bear markets can be miserable as you watch your favorite stocks freefall with no justification. This action is inevitable due to the cyclical nature of markets. It occurs on a regular basis and can't be avoided. Even the best traders will suffer significant losses in these periodic meltdowns.
In the worst bear markets, it feels like you will never make money again. It is easy to be pessimistic and negative, but like day follows night, the good times will eventually return. The good news is that this terrible market action always leads to exceptional opportunity. Bear markets produce substantial mispricing in individual stocks. Smaller and illiquid stocks, in particular, are prone to be sold without any regard for their individual merits, but nothing is immune when the bears take charge.
Unfortunately, most active investors don't do a very good job of embracing these opportunities. The biggest mistake by far is being too anxious to jump in when the price action is poor. The desire to catch the exact turning point is a recipe for premature accumulation.
When you start to accumulate a stock too early there is a tendency to keep adding as it goes even lower. Eventually, the position becomes uncomfortably large, and when it fails to bounce back, the stress becomes too great, forcing an emotional sale and causing a big loss. More traders are wiped out by buying too big and too fast in a down-trending market than anything else.
The remedy for this problem is to follow the advice of Ted Williams and Warren Buffett and wait for your pitch. Hall of Famer Ted Williams believed that the key to hitting success was patience. He only wanted to swing at a pitch in his "happy zone," which is the part of the strike zone where he was most likely to hit with power. Williams broke down the strike zone into a grid of 77 baseball-sized cells and assigned batting averages to each. For example, a pitch right down the middle might generate a batting average of .400, while a low and outside fastball would produce a batting average of .230.
For active investors, Williams's approach to hitting is equivalent to waiting for setups that match your strengths. The goal is to find the right stock in the right sector with the best setup at the right time. There will be plenty of pitches that you could swing at, but you want the one that is in your sweat spot.
Warren Buffet has often cited Ted Williams's baseball advice to wait for your pitch, but Buffet points out that in investing, unlike baseball, there are no called strikes. You can let hundreds of opportunities pass until you see the perfect setup.
The biggest obstacle that investors face when employing this approach is their own impatience. When you sit in front of the screen watching a massive meltdown, there is a strong desire to do something. When the world is going nuts, we want to jump into action. It is extremely hard not to take some swings, but as Buffet once said, "The stock market is a no-called-strike game. You don't have to swing at everything—you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!'"
While waiting for your pitch, stay very cognizant of the market noise and the emotional traps that it can create. One of the easiest things to do is to tell yourself that there will never be another opportunity like this when the market suddenly drops 10%.
The reality is that the very best opportunities don't just exist for a single day. They develop over weeks and months. The big money is made by waiting for technical conditions to improve and then riding the new uptrend as it develops and gains momentum.
The big mistake is thinking that you have to identify exact turning points. That is a very popular game on Wall Street and leads to serial losses as traders repeatedly try to call turns. A sudden sharp drop is usually not the best pitch to take a swing at. The best pitch is going to be a clear technical setup with the right market conditions.
Develop a trading plan and be clear about the pitch that you want to take a swing at. Stay patient and wait for that pitch. Don't be tempted to waste your time swinging at garbage. Focus on fewer, higher-quality setups. Buffet's partner, Charlie Munger, often referred to the time waiting for your pitch as active patience. You are constantly watching and looking for the right pitch. There is plenty to do while you patiently wait for the right combination to appear.
At the time of publication, DePorre had no position in any security mentioned.
