Dealing with the next US correction

For the Singapore market, which moves more slowly, the defensive practice of selling your securities and buying back lower can be executed rather safely. However, in the American markets, such a practice might be dangerous. Therefore, many long-term investors suggest buying and holding - adding to those positions as the prices find new bottoms. This is especially so for fundamentally strong companies which you have conviction for. It is very important to have conviction for the company you own, as otherwise, your hands will be paper-hands and it is terrible to die of a thousand paper cuts (In Singapore, we call them "cut -loss experts": stop loss on positions just because of a slight-moderate swing in stock prices, only to see prices rally against you later - especially stronger and fundamentally strong counters).

Indeed, by the time emotions lead to you selling your securities, they have found their daily bottom and you might be pressurised to add back your positions at a higher price in the ensuing hours or days (sell low, buy high) only to be fooled by the fake market rally (usually initiated by experienced contrarian funds and day traders), with prices diving down further again after these market participants have left, amplifying your losses further.

This matter is complicated further by the US post-market and pre-market system, such that selling a security and averting some losses initially (and not buying back, in the hope that the prices will find new bottoms in the ensuing days) can lead to disastrous consequences the very next day (and the swing can be much more massive than in Singapore), with stocks trading much higher in the pre-market and regular trading hours initially (in such a case, one is advised not to buy pre-market or in the first hour - if there is a positive market reaction, it is typical that prices will rocket up before plunging within the first hour because the experienced contrarian day traders start to short the stocks which have flew up too fast (over-extension of stock prices) in a weak corrective backdrop).

If one has bought into positions at key support levels, the most prudent thing to do is to hold and add to any possible fall - treating it as an opportunity to buy good stocks at discount prices. This is especially when the stock and/or index has tested and appears somewhat to be supported by the key static or dynamic support. 

In terms of hedging with derivates like ProShares UltraPro Short QQQ (counter: SQQQ) , it is only wise to start hedging at the initial phase of a stock market correction or crash. The ProShares UltraPro Short QQQ is a 3x leveraged inverse ETF which tracks the NDX (Nasdaq-100). It is meant to be held intra-day and not meant to be a long-term investment because there are expenses which are incurred daily, and these will eat into your returns. Hedging using derivatives should be done such that there is still a positive expectancy if and when the stock market recovers (it is likely the market will recover). Treat it as a form of insurance - best applied in the initial high momentum phase of the stock market correction and not during the later post-bottom recovery phase. If you have applied a hedge using the SQQQ (or other derivatives) during the initial strong downward correction phase, there is no need to rush to cut losses against a counter-trend upwards move if there is general market weakness (but do remember to lock in profits - as little as they may be, else profits can quickly turn into losses when shorting a security).

Once you have more than 50% confidence that stocks have resumed their uptrend, as indicated by momentum indicators like RSI, ADX, MACD, etc, one should avoid hedging (and take profits from their short positions) because the trending move (recovery upwards) is going to be stronger than the counter-trend corrective pullbacks and hiccups the stock or index may encounter in the coming days. By continuing to hedge or by initiating a hedge, one is limiting the profits he/she gets. If it is a speculative hedge, such that the hedge applied is more than the capital one holds, then one risks losing money.

As such, the general guidelines for dealing with the next US market correction are:

1. Hold your shares and use the opportunity to add new positions along key supports - they may be fixed supports or dynamic supports like the 50, 100, 150, 200 SMA (Simple Moving Averages). The US market is typically very strong and will likely bounce back up again. Alternatively, one may wait for the first green daily candle to appear on high volume, and add positions. This is safer as it limits the losses that you may have to endure - particularly those who cannot stand to see red. 

2. Once positions are initiated in (1) or when existing positions are added to the initial positions based on (1), one should HODL - hold on to your dear life. Not every market reaction deserves a response and over-trading should be avoided, especially if you are new to the US market. The US market is very volatile and over-trading can lead to amplified losses, especially with the immense possibilities in terms of political news which can lead to immense (and possibly temporary) swings either way and the extended trading hours in the NYSE. More money can be lost preparing for and handling a correction than the correction itself.

3. A hedge position can be rather safely applied, if it is less than the capital sum of your long positions - especially during the initial phase of the downturn. Confirm the initial phase of downturn using indicators which measure the strength of a move, such as the ADX.  Once you have initiated a hedge position, try to hold it as there is general market weakness, and only close the short position when there appears to be some support at the key levels. Do not initiate hedge positions after the initial corrective phase appears to be over. 

In summary, the US market is very volatile and normal technical analysis may not apply in light of rapid changes in macro-factors as well as news that can cause massive pre-market and post-market movements. 

As such, it might make better sense, especially for a new market participant not used to the US market, not to actively manage a correction and use the opportunity to buy on the dips at crucial support levels in batches, especially after one has done research on stocks which one has conviction to hold for the medium-long term as they are fundamentally sound companies which have unfairly been punished during the correction as a result of over-reaction or bearish market sentiment. Use the opportunity to get a rest and do some quiet research on equities (turn off the brokerage screen if you need to focus or rest), so that you plan which to buy - and make sure these are stocks you have thorough conviction in - otherwise, without a thoroughly researched investment thesis, you might experience immense psychological pressure to sell them as the stock starts dropping badly (only to have the stock rebound against you sharply after you have sold it!). Also, if you did not research carefully into the stock, and insist on holding it with diamond hands, you may be shocked a few days or weeks later to find that the security has plunged tremendously and will never rebound. 

Only buy fundamentally sound companies if you want to make money. As value investors like Buffett and Lynch suggest, when you buy shares of a listed company, you are actually owning a small  (or large) part of that company. You want to grow with the company - the market respects over the long-term (though there may be rapid swings up or down in the short-term) increasing earnings per share (EPS), free cash flows (FCF) and the true value of a company will gradually be unlocked in a few months to as long as three to five years.

And when the market price has sufficiently rallied, it is time to sell half or all of the shares gradually as prices start to increase if, taking a long-term or moderate-term view, the stock is now "expensive" or "too high" (one must be careful, of course, not to sell his winners too early).

At all times, perhaps it is best to take note of Warren Buffett's prudent advice that the stock market is a great device for transferring wealth from the impatient to the patient.