Time to Dig In and Save Your Bullets

06/06/2011 1:44 pm EST

Focus: MARKETS

Michael Cintolo

Vice President of Investments and Chief Analyst, Cabot Heritage Corporation

Don’t make the mistake of overtrading this pullback. Work on your shopping list instead, and wait, writes Michael Cintolo of Cabot Top Ten Weekly.

Anyone paying attention to the market during the past few weeks knows the bulls aren't exactly putting on a good show.

Starting in early April (earnings season), many leading stocks began to sag, and a few broke down in violent fashion. Now the weakness has spread to the major indexes, most of which have decisively penetrated their 50-day moving averages.

In other words, the market is in some sort of correction here—the sellers are taking control. Now, when I say correction, I don't necessarily mean the indexes must fall at least 10%, or follow any other common "definition" of a correction; I don't predict that sort of thing. I'm simply describing a general down period for most stocks, lasting at least a few weeks.

My experience is that, when the market heads lower, it's almost always accompanied by a pickup in volatility, both among the indexes as well as among many individual stocks.

What does this enhanced volatility prompt most investors to do? Increase their trading activity, both to respond to the action of the stocks they own (usually damage control) and to take advantage of perceived opportunities (bargains, baby!)

Thus, the investor who might average a trade or two per week suddenly makes four or five moves every week. And more likely than not, the only one making money during this period is his broker.

I've seen this play out time and again. It's part of the natural market cycle for an investor to make decent money during an uptrend and then lose some of that during the first couple of weeks of a market decline. Then, during the decline, instead of hibernating in cash and cutting back on new buying, he loses his cool and starts churning his account in a big way, losing most of the profits garnered during the bullish period.

The fact is, being an investor is not like any other profession. At any job, you head into work every day and you try to get things done—you attend meetings, make presentations, put together sales pitches, work on marketing, troubleshoot product development issues, and so on. If you don't do this, you'll likely end up losing your job.

On the other hand, a good investor will have periods when it's difficult to keep up with what's happening in the market—stocks setting up, breaking out, following indicators, setting stops, knowing the earnings dates for stocks one owns or wants to own, etc.

But there will be other times when it's appropriate to do nothing. Sometimes for weeks at a time.

I understand such inaction is hard, especially when our day job consists of getting things done. But in life, as in investing, circumstances sometimes emerge when less is actually more—and I think that's the case in this market, at least until the bulls retake control. Right now, you need to stay calm, control your emotions—and embrace the wisdom of inaction.

Besides, during these down times, you're not actually doing "nothing." Sure, your trading activity should fall way off, but you should work on building and (just as important) maintaining a shopping list of potential new buys, so you can jump back in once the market begins a new uptrend.

Now is the time that truly separates the great investors from the run-of-the-mill ones. The great investors pare back their trading and build a watch list; the mediocre investors up their trading (and likely lose more money than necessary). And, because they’re so busy, they have no idea what the new leaders will be when the market gets going again.

Ironically, the more work you put in today in creating and massaging a watch list, the less work you'll have to do when the bulls return, and the better results you'll have.

I heard a good analogy about two people running a marathon. One is completely out of shape, while the other has been training for months.

Not surprisingly, during the marathon, the one who hasn't prepared expends all sorts of energy, but can barely get past a mile or two! The well-trained athlete, of course, not only runs effortlessly but posts a great time as well.

That's the idea today; while you shouldn't be "active" in the normal sense of the word, you should prepare for the next up leg. My experience tells me that's the hardest thing for investors to do; when the news is bad and their portfolios are down, the last thing most people want to do is hunt for new, potentially big winners.

But if you're looking to truly take advantage of the next bull move, I urge you to trade less today, and instead, focus your energy on some research and watch list-building during the market's soft spot.

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