I don’t have to tell you that it has been tough out there for the past few weeks. However, there is no real reason not to take advantage of every profit opportunity available, however scarce they may be. At the same time, there is nothing wrong with being cautious and defensive.
For starters, it might be prudent to limit your exposure to small caps as the market goes through a trend reversal. If for no other reason, consider that as the market contracts, small caps exponentially increase their cash burn rate just to keep up with expenses.
In a perfect world, things are supposed to work like this: Companies make sure they keep on their projected growth path, while the capital markets make sure the stocks receive a fair price.
The only problem here is that, while such a scenario may come into play during a bull market, the “perfect world” theory rarely works during bear markets. Meaning, companies must look after their stocks’ prices as well. One way companies boost their stock prices is buying back some of the outstanding float and creating new buying pressures. The downside is that the money is coming from the companies’ treasuries, thus limiting their growth abilities.
Perhaps the best thing to do as the market downtrends is to become a more active trader and leave behind the good ol’ buy- and-hold maxim for the time being. Instead, switch from long term stocks to more volatile ones.
Of course, I do not suggest that you should jump into momentum plays every time someone says so. Instead, look for stories that are temporarily out of fashion, so to speak, or sectors that have taken hits just because the rest of the pack got too excited, too fast, too soon.
Currently, gold seems to be out of vogue, despite the sector’s fundamentals being strong, thus making gold stocks good laggards to explore. Just remember one thing–the way things are going right now, you should only be in the gold game for fun and, even then, only on a short-term basis.