Teeka Tiwari

Your No. 1 Weapon for Surviving This Mad Market

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It seems that perhaps the market has gone mad.

The last time I saw this many bearish signals reverse was in early 2007. The brokerage stocks had been running like crazy, but I knew their balance sheets were rotten with souring mortgage bonds. What's more, all of the sector data pointed to massively overbought conditions.

At that time, I repeatedly attempted to short the brokers and got stopped out again and again. It seemed that every time a meaningful sell signal was triggered, buying would magically appear to eliminate the sell signal.

When the NYSE Bullish Percent Index (BPI) flipped to Os in early 2007, I got even more bearish. But just a few weeks later, the index flipped back to Xs, once again wiping away my sell signals. (On a very basic level, Xs represent rising prices and Os represent falling prices on the BPI.)

This was a very frustrating time. Everything screamed "Sell!" and, yet, the market just kept coming back.

I knew that the subprime bubble was going to wreck the brokers; the story was already out there and, yet, they refused to break.

It wasn't until June 2007 that we finally saw sell signals start to "stick." Of course, as we all know now, early 2007 proved to be the top for the entire financial sector.

The past few months, we've seen the same type of thing happening. Whether it's market manipulation, irrational exuberance or the start of a new era in American profit growth, the market is consistently reversing every single bearish indicator.

2 Tools for Surviving This Market

So how do we survive the whipsaws that can corrode our trading capital while we wait for the signals to begin sticking?

There are two keys:

1. You must use stop-loss points on every trade.

2. You must use dynamic position sizing that adjusts your position size as a set percentage of your equity.

I've written about how to determine your stop-loss points in the past, so I'd like to focus on position sizing here.

Dynamic Portfolio Management

Dynamic position sizing means that, as our account value fluctuates, so should our position size.

To keep our position size uniform in relation to our expanding (or contracting) account value, we want to use a set percentage of account value to determine our position size on an ongoing basis.