The S&P 500 is down over 4% after hitting an all-time high on July 16.
If you’ve been following along, this shouldn’t come as a big surprise.
Market “rotation” is currently underway, with money moving out of mega-cap stocks and into other areas that have underperformed.
Traditionally, this is a sign of a healthy market…
But that doesn’t mean you shouldn’t prepare.
So, today, I’m sharing my top three rules for dealing with market pullbacks.
First, realize that not only are pullbacks normal and healthy after such a big runup…
They can also be blessings in disguise.
One, they “reset” the market. During bull markets like today, they allow stocks to build up energy for their next move higher.
Two, they make it easier to identify true market leaders. They show us what stocks are the “real deal”... and which ones are pretenders.
Rule 1: Identify the sectors and industries holding up the best.
This will help us know what areas of the market money could “rotate” into. Right now, I’m keeping a close eye on utilities, consumer defensive, and healthcare stocks.
Once you’ve identified areas of the market holding up the best, look for stocks within those areas that are showing relative strength.
Specifically, look for stocks that are flat or up on days the market is down.
Rule 2: Wait for stocks to stop going down.
Rookie traders often buy sell-offs too early.
They buy when the market is still falling… exposing themselves to quick losses that make it hard to stay in a trade.
Instead, when “buying the dip,” wait for stocks to stop falling.
Not only will you boost your odds of profiting…
You’ll have an easier time managing risk. That’s because you can use the stock’s recent low as a line in the sand to exit your position.
And that brings me to my next rule…
Rule 3: Use stop-losses and exercise proper position sizing.
Stop-losses get you out of a position if it closes below a certain level.
They keep small losses from spiraling into crippling losses, which can ruin an account.
They also take the emotion out of trading… but only if you stick with them.
Proper position sizes are also one of the best ways to keep yourself out of trouble as a trader.
I size my trades based on a stock’s overall risk level, the stock’s “personality,” and my overall conviction level.
The riskier the trade, the smaller the position.
Sizing trades correctly doesn’t just preserve your trade capital. It also protects your mental capital.
In other words, proper position sizing will help you sleep at night.
You’re less likely to worry about the daily moves of a position, which can keep you from getting shaken out of a trade.
Justin Spittler
Chief Trader, RiskHedge
