What I Learned in the Market Collapse

The rapid market downturn over the last 5 months, and especially the stunning January collapse, has been the most difficult investing environments I've ever seen. Even the tech meltdown in 2000 and 2001 was much slower moving, offering greater room to maneuver on the way down. Traders for whom I have great respect, such as Dennis Gartman of the "Gartman Letter", with 25 years of trading experience, have stated that they have never seen anything like the continuing difficulty and violence of this market. Like most, I took it in the throat.

Here are a few of the lessons I intend to remember "next time":

1. It is always better to be out of the market and wish you were in, than to be in the market and wish you were out.
2. It is OK to just sell everything so you can sleep at night and live to trade another day when the market finds a stable bottom.
3. A violently volatile bear market means that you have to dramatically "shorten your swing". There is actually great opportunity to make some money by buying extreme weakness and selling the sharp bear market rallies. But to do so you have to be very nimble, taking quick gains and being more willing than not to leave some potential profits on the table.
4. Hedges matter. As I finally got me head around the type of market we were really in I switched to a trading profile that was much more hedged, limiting my upside but also significantly protecting my downside. For example, I set up many of my long positions, especially the higher beta positions, as vertical call spreads (buy a call at one strike price and sell a call at a higher strike price with the same expiration date). This allows me to capture the upside to a certain strike price while greatly reducing the cost of the long side of the spread. When the market makes violent moves up or down I can take off one side of the spread and capture those profits and then reestablish the spread when the stock moves back the other way.
5. When great profits have been made in the market, always take some off the table and put it away somewhere safe.
6. It is important to always have some money on the side to take advantage of stocks that are unfairly punished. Too many people are too fully invested too much of the time.
7. Professional traders and investors understand that in a difficult tape it is more important to limit the downside risk than it is to maximize upside gains. Personally, this is an area of discipline where I will do better going forward.
8. You have to find a way to "stay in the game". Otherwise, when the rebounds occur, you don't benefit from the ride up. You end up selling low and then buying back in high.