Michael Taylor continues his bear market series by focusing on process over prediction, showing why waiting for confirmation beats trying to call the bottom. He also explores the mental discipline needed to endure downturns and stay positioned for the eventual recovery.
This is the second article of a two-part series.
If you’ve not read the first article – you can do so here.
Process, not prediction
Here’s the thing that nobody in the financial media wants to tell you: nobody knows when a bear market ends.
Not the economists. Not the central banks. Not the hedge fund managers on Bloomberg TV with their confident forecasts. Definitely not me trading from home.
The Bank of England said this week that stock markets were too high and set to fall.
But the deputy, Sarah Breedon, said: “What we are watching for: is how might those prices fall? Will there be a sharp adjustment downwards? And if there is such an adjustment, how will that affect the economy? I’m not saying it will happen today, tomorrow, in 12 months’ time.”
So basically, she’s saying something could happen, at any time. Which isn’t really much use.
The people who called the bottom in March 2020 were largely lucky. And in 2008, the periods where it looked like the worst was over (but wasn’t) were numerous and brutal.
If you try to trade a bear market by predicting when it ends, you will almost certainly be wrong. You are basically betting that you’re printing the bottom. You’ll buy too early, get stopped out or panic sell, then watch the market recover without you.
The better approach is to let the market tell you when conditions are improving. I use the Stage analysis framework that I’ve written about extensively before – Stan Weinstein’s four stages.
It was my first article for ShareScope back in 2019.
And seven years later, it’s still a must-read.
Stage 1 is the basing phase after a downtrend. Stage 2 is the uptrend. Stage 3 is the topping phase. Stage 4 is the downtrend.
A bear market, broadly, is a market where more stocks are in Stage 4 than Stage 2. You shouldn’t be aggressively buying Stage 4 stocks in the hope they’ll reverse.
The question you should be asking is: are more stocks starting to build Stage 1 bases? Is the character of the market starting to shift?
In 2009, it wasn’t obvious on the first day of March that the market had bottomed.
But over subsequent weeks, you could see the selling pressure easing, the basing patterns forming, volume characteristics changing.
The traders who came in methodically, buying when stocks showed genuine Stage 2 breakouts with volume, made extraordinary returns in 2009.
The traders who tried to catch the knife in October 2008 and November 2008 mostly gave up before the real recovery came.
The mental game
Bear markets are psychologically exhausting in a way that bull markets never are.
Losses are painful. Watching positions that you believed in collapse is painful. Reading headlines screaming about recession and crisis is painful.
There’s always temptation to check your portfolio every five minutes. Or waking up in the middle of the night thinking about your stocks. The creeping voice telling you that maybe you’re just not cut out for this.
I’ve been there – it’s horrible.
What I’ve found actually helps is boring. Keep a trading journal. Log every trade – the entry, the exit, the reasoning, the outcome.
In a bear market, what you’re looking for is whether your process is sound even if the results are temporarily bad.
If you’re following your rules and losing money, then that’s not an issue. But if you’re breaking your rules and losing money, that’s a different problem entirely.
The traders who don’t survive bear markets usually fall into one of two camps. Either they abandon their process entirely and start making increasingly desperate bets trying to win it back. Or they get so burned that they give up and never come back, missing the bull market that follows.
The goal of a bear market, if I had to reduce it to a single sentence, is simply to still be here when it ends.
Mark Minervini says he sits out of the market when the market is bad. He only trades in bull markets when the conditions are ripe.
It’s easy for him to do so because he has a business that pays him outside of stocks, but this is why if you’re going to trade full time you need to be sufficiently capitalised or have other sources of income.
That requires position sizing that keeps individual losses small.
It requires stops that prevent small losses becoming catastrophic ones.
It requires the willingness to hold cash and accept that not losing is itself an achievement.
And it requires a process that lets the market – not your emotions – tell you when conditions are improving.
None of this is glamorous. It’s not the exciting stuff you see on Industry or in The Big Short.
But it’s what actually works, and will keep you in business when the tide turns.
Michael Taylor
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This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.
This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.
