One of the most interesting things in the stock market, is watching people trade stocks and engage in crowd behavior.

This has been very evident in the recent market decline. When the market was going down, the crowd was selling into at any price, causing the stock market crash.

In the media, at the same time, all the voices were discussing selling, selling, selling in a uniform chorus.

As you can see from the market action, the herd suddenly stampeded, almost without warning into a 13% market decline in only five weeks until the end was reached and even then extreme volatility prevailed.

What should your stock trading strategy be?

Market Making

My experience as an OTC market maker gives me a unique perspective on these types of stock market trading and stock market crashes.

Imagine being a professional stock trader, a market maker. You have a certain amount of capital. If you do are loaded up with inventory and do not anticipate a stock market crash like the one we just had, you are doomed.

If you have, say, $1 million in inventory, to pick a round number, and you are 80% long, in a 15% market decline, you lose on average $120,000 in a matter of weeks. If you had to repay your losses, you were not a happy stock trading professional.

On the other hand, if you were net short 50%, you made $75,000 in only a few weeks.

As you can see, being a market maker you will either learn to anticipate and profit from the crowd, or you will find yourself serving chopped liver as a clerk in a Wall Street delicatessen in short order. Getting carried away with the crowd is a sure ticket to the deli.

I didn’t average 300% per year gain on my trading positions by being slow to learn. If I was wrong, the market kicked my ass hard. So you learn fast to develop the right reflexes.

Now here comes the tricky part for any stock market trading as a market maker – when to load up, when is the bottom, when to dump, when is the top?

You do not want to get in front of the moving train and buy on the way down. You do not want to be the pioneer when the stock market crash seems to halt, only to find out that the market has more to move down.

The way to do that is simply to anticipate. You have to be short before the decline, long before the rise.

The only way you can execute your stock trading strategy is to be able to brush aside all the crowd mentality, all the herd instinct. If you see everyone bullish, you have to be bearish and looking to lighten up and go short. If you see everyone selling in a stock market crash, you have to start to look for the buy point.

It is that ability to maintain a clear head and observe others instead of getting carried away by them or with them that leads to profit.

Stock Market Gurus

Look at Warren Buffett buying into Bank of America when it was the poster boy for the recent stock market crash. Nothing but bad news on BOA.

Look at the smart hedge fund managers who shorted the mortgage business before it became apparent that it was a bubble.

These people had the courage of their own minds and the ability to act in defiance of, actually in opposition to, the crowd.

Remember, we don’t get in front of the stampeding crowd in a stock market crash – too dangerous – but we do wait for them to make the mistake of overselling the market. When that market shows signs of turning, we look to buy.

When there is a bubble, we look to short.

This is why the simple strategy of being a contrarian works for some money managers.

However, there is more to it than that, more potential for big profits. You must trade with the trend but anticipate, judge trends and market momentum and look to get in at the right price.

Remember it is lonely. In one of my better calls, I had my clients mostly in cash and holding off buying after the market peaked in August 1987. The day after the October crash, I called them and issued a screaming buy recommendation as it seemed to me that the panic had worn itself out. We had reached the low. Few of them could summon up the courage or the cash to buy, but those that did never saw prices that low ever again. Buyers were scarce and people who were putting out buy recommendations were even more scarce, but that was the right time to buy.

Are you starting to see that you need to have an independent mind and the courage of your convictions to win in the stock market?

Bear Markets

One more observation. If you can figure this out, let me know. The best stocks I have found have been in bear markets. True, you could buy just about anything in a bull market and be up, but the highest percentage gains in my book have been in bad markets. Not terrible markets, bad markets. I have never figured out why.

Stock Market Press

I would like to warn you about the stock market media. The commentators are sharp but the overall look in the media is simply a reflection of crowd thinking. If the market is going up, the news presented is optimistic. If there is a stock market crash, no good news will appear. They seem to focus on the current trend but we, in our stock market trading, as a matter of stock market strategy, must anticipate.

Yes, it is good to know what the current trend is but only because that is the platform, the starting point, from which you anticipate.

If there is a stock market crash, you anticipate change, you anticipate the turning point. If there is a bubble, you anticipate the bursting of that bubble.

So you have to know where you are now, but you are always looking where you are going in the future, then you can position yourself where you want to be.

There is an overall trend in hedge fund and portfolio managers to trade the last three months of the market. If the market has been up, they want to buy. If the market has been down, they want to sell and go short. This is the way to go broke.

You trade the future. You do not allow your mind to be influenced by the past. You anticipate.