Michael Taylor explores what really matters when markets turn hostile, cutting through the noise with practical lessons from past crashes. He shows why survival – not prediction – is the key to coming out stronger on the other side.
There’s a quote often misattributed to various people.
My favourite is the one in The Big Short.
“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so”.
This quote is attributed to Mark Twain.
Except Mark Twain almost certainly didn’t say it.
Was this a hidden Easter egg for those paying attention? Or did the producers think they knew who said the quote, and thus getting in trouble as they put it in the film for being sure of something that just wasn’t so?
I suspect I will never know the answer.
But there is another famous quote..
“Everyone has a plan until they get punched in the face.”
Mike Tyson did actually say this, only it was the mouth. And the second, and more telling part, is always left out.
“Then, like a rat, they stop in fear and freeze”.
Bear markets are the punch in the mouth.
The Covid crash in March 2020 was one of the fastest and most violent drawdowns in stock market history – the FTSE 100 dropped roughly 35% in about five weeks.
The 2022 rate hike cycle quietly destroyed portfolios for an entire year, with growth stocks and AIM in particular getting absolutely obliterated.
And if you’re old enough to remember 2008 (my money was spent in student bars rather than stocks), you’ll know what genuine systemic fear looks like. From what I have heard, people weren’t sure if the entire system would collapse.
Indeed, former Chancellor Alistair Darling said he received a phone call that “shook him to the core”, as the then Chair of RBS (the biggest bank in the world at the time and the same size as the entire UK economy) was about to run out of money in a few hours.
If that had happened, cash machines would’ve gone dry, and money would not be able to be withdrawn from banks. It would’ve caused panic on a mass scale, and it was only a few hours away from happening.
Thankfully, it didn’t, as the knock-on effects would’ve been catastrophic. But still, markets recovered and powered onto new all-time highs.
And every single time, the same thing happened.
People who had no plan panicked and sold at the bottom.
People who had too much size got margin called or wiped out.
And a small number of traders came out the other side in better shape than they went in. Not because they predicted it (I am not clever enough for that), but because they had a framework that let them survive long enough to take advantage of it.
Here’s what actually matters when markets turn against you.
Position sizing
I’ve often said that position sizing is your first and last line of defence.
And the best time to manage a bear market is before it starts.
The reality is that most of the damage traders suffer in a downturn isn’t caused by the market falling, but by traders holding too large positions than then fall that they do nothing about.
The problem with position sizing is that concentration builds wealth. So it’s very attractive in bull markets. But oversized positions can tank quickly, especially with big volatility.
When volatility expand, stops should become wider to account for that and therefore position sizes get smaller.
But when stops are hit, you need to get out. It doesn’t matter how good the stock is and how much you believe in it – stocks can become very cheap, and become even cheaper.
During Covid, I was stopped out of lots of positions in quick succession. If the market had then rebounded without me in it, then that’s fine. That’s the system working. The stops do their job of containing losses, and allowing me to survive another day.
Position sizing is boring to talk about. But in a bear market, it’s the difference between a difficult quarter and a catastrophic one.
Do not get overly confident in a bull market. Make sure you know exactly how much you have at risk, and monitor this vigilantly. The market can turn at any time, as we’ve seen in the last few years.
As a trader much better than me once said: “Lazy longs don’t stay lazy for long”.
Stops aren’t optional
Mark Minervini has said that those who trade without a stop loss eventually stop trading. He’s right. In a bear market, that statement becomes brutally literal.
In 2022, I watched stocks I’d been watching for years lose 60, 70, 80% of their value. Thankfully I wasn’t holding. But stocks that were cheap became cheaper, and became cheaper still. These weren’t terrible businesses in every case. Some of them were profitable, growing companies.
But the market had decided to reprice everything, and a stock that looked expensive at 30x earnings in January looked even more expensive at 20x earnings in March and 15x in June as rates kept rising.
The investors who held on and “waited for it to come back” sometimes saw the stock come back, and in some cases are still waiting. The traders who had stops in place took their losses early when they were small and moved on.
There’s a well-documented psychological phenomenon called loss aversion – the pain of a loss is roughly twice as powerful as the pleasure of an equivalent gain.
In a falling market, this destroys people. You hold because selling feels like crystallising a loss. The stock falls further. You hold because now selling at a bigger loss feels even worse.
Eventually you either sell at the bottom or you end up riding a single position to near-zero.
The stop loss removes the emotion from that decision entirely. It makes the decision in advance, when you’re calm, before you’re sitting there watching your P&L fall and convincing yourself that “it’ll bounce.”
It might bounce. It might not. The stop doesn’t care about the story. And in a bear market, you shouldn’t either.
Cash is a position
I learned this very early in my career, and I suspect it trips up a lot of people who come from a long-only investing background.
We’re conditioned to think that being in cash is somehow a failure. You’re missing out. The market might recover. You should be fully invested. This is drivel.
In a genuine bear market, cash is the best performing asset in your portfolio. It doesn’t go down. It gives you optionality. And perhaps most importantly, it preserves your psychological capital at a time when that’s in desperately short supply.
During the 2020 crash, the traders I saw make the most of the eventual recovery weren’t the ones who sat through the whole thing fully invested. They were the ones who raised cash during the fall – either because their stops triggered or because they made a deliberate decision to reduce exposure – and then had dry powder to deploy when the market turned.
The bounce off the March 2020 lows was extraordinary. But you could only take advantage of it if you had cash to put to work. If you were fully invested, your hands were tied. All in is boxed in.
There is no shame in sitting out. There is no law that says you must be in the market at all times. If you can’t identify trades that meet your criteria, if the market is handing you a tape that doesn’t suit your strategy, then not trading is a perfectly valid position.
I’ve had extended periods where I’ve done very little.
Not because I’m lazy, but because the conditions weren’t there.
In a bear market, the probability of a random long trade working is lower than it is in a bull market. This is just simple mathematics. More stocks are falling than rising. The wind is in your face.
Reduce exposure. Let the stops do their work. Sit on cash. Be patient.
Michael Taylor
Get Michael’s trade ideas: https://newsletter.buythebullmarket.com/
Free educational content: @shiftingshares
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.
