Plan for the Impending Rally - Part 1

This past week saw historic market losses; in fact it was the worst week ever for the stock exchange. The cover of Time Magazine shows a soup line from the 1930’s and questions if we are heading for another depression. Many popular commentators now openly use the term “Great Depression 2” as a real possibility if the markets cannot be righted. For the first time in my life, excluding 9/11, there is genuine almost primal fear in the country. Yet history shows us that these times may be the best to start putting money back to work in the market. In order to fully capitalize on this opportunity you must have a game plan to take advantage of the impending rally.

John Boik discusses many market crashes and the ensuing market rallies in his book How Legendary Traders Made Millions. Each market crash such as 1929, 1962, 1973, 1987 and 1998 saw significant market rallies that bagged gains of 50%, 100% or more in the subsequent recovery. No matter how bad the market gets, it will always make a rally attempt.

This does not mean that the market bottoms, rallies, and then goes straight up. The 1974 recovery saw the market bottom in the fall of that year, rally for 5 weeks then roll back over undercutting the prior lows. The market then got itself back together in the beginning of 1975 before it started its big run. Monday saw the US exchanges rocket over 11% in one day. Many people may take this as a signal that we have bottomed, but historically big one day percentage gains often happen during a Bear market so caution is still advised.

Who knows how the market will recover from the 2008 crash, but there are three distinct rally scenarios that you must be ready for.

1. The markets will rally and logged a quick gain of 20%+ since stocks have been beaten down so much and so quickly by panic selling.
2. The markets will put together a suspect rally that last for several weeks which is just long enough to get people to start buying again before it rolls over and heads lower.
3. The market will rally but trend sideways for several months in order to heal itself before heading higher or potentially lower based on world events.

How should investors approach the three scenarios? In general, there are two classes of investors, the first group is long term mutual fund holders and the second group is short term traders who invest in individual securities. Each should approach the market differently.

If you are a long term mutual fund holder who makes monthly contributions towards your retirement and you have a 10-20 year horizon then stay on track and resist the urge to stop putting money into the market because of scary headlines. The markets will certainly be higher 20 years from now and you will be well rewarded.

For those of you who want to invest in individual stocks your job is much harder but it does offer greater rewards. To maximize your gains you must have a game plan and a system to capitalize on the impending rally while protecting yourself from a potential market head-fake. Your system and game plan should include the following:

1. A signal that the market has bottomed and is now heading higher
2. A process to identify the strongest stocks in the strongest industries as the market turns
3. A money management plan which allows you to put more money to work if the market appreciates
4. A stop loss policy to protect your capital if your individual security begins to crumble

Monday’s big gain offers hope that the worst is behind us and that we may be at dawn of a new golden Bull market. The only way that we will know for certain is if market prices continue to rise. Caution is the way now; make sure that you have a plan and a system that can help you navigate these historic but dangerous times. If you do not have a system, I strongly suggest that you visit Investors Business Daily and get a free two week subscription to this great publication.