The view from the bottom

Dear Warren

I don't know. I'm not that smart, and anyone who says they know is guessing at best and deceiving you at worst. Because they don't know.

In Japan, the equity market has fallen a compound 7.6 per cent each year for 20 years. Greater men and women than you and I have called the bottom on that market a thousand times in those 20 years and they are all still wrong. Mortal man is, it seems, not up to this task.

The bear market will end when the market says it has ended, and that will be before the economists declare it or the numbers show it. It will happen when the headlines are still terrible and it will happen for some imperceptible reason that you won't perceive. You'll only know it's been, when you've missed it.

If "participation" in a bull market is half the game won, participation in a bear market is half the game lost. Anyone who charges the guns in a bear market is nothing short of heroic. You cannot afford to participate in a bear market and, as many of us have found in the last year, participation through a long-term diversified portfolio with all its sins (hope, faith, laziness and inaction) has been a disaster. We need to do something better. So here's a plan. The focused trading plan.

We talk about "the bottom", and no doubt the line that represents the ASX 200 index will, one day, "bottom". But the truth is we have three major sectors in the Australian market that are hardly connected. Financials, Resources and Industrials. You could even find a fourth at the moment, Property, which has recently developed an unfortunate independence of mind. When you ask about the bottom, you have to ask "which one", because they will all come in different sectors at different times. Focusing on "the index" is missing the point. To make way in a bear market, we have to focus not on the market, not on portfolios, but on sectors and on individual stocks. We have to trade stocks, not invest in the market.

When it comes to buying individual stocks, the only thing to trust is momentum and, in particular, momentum change. Buy into rallies when they happen, especially when there is some believable "big driver" to warrant the sentiment change. As I write, for instance, the resources sector is having a moment of resurrection. Chinese steel prices are on the mend, iron ore spot prices have risen, freight rates are up, BHP tells us the Chinese destocking process is almost over and those moving averages on the Chinese stockmarket are about to cross on the way up. BHP, Rio and Fortescue Metals are suddenly going up.

This is the game: spotting a change in sentiment and trading with it. It is not grand. It is a trade, a focused trade. What the ASX 200 is doing is irrelevant. In fact, the ASX 200 would have hidden it, because the financials and industrials have been doing something completely different.

But before you rush off and buy resources, understand this. You can only trade in a bear market if you have the discipline to retain tight stop losses, to maintain them on a daily basis, to roll them up when you win and to act on them when you're wrong. It takes effort - an effort portfolio investors are not used to.

It is a traders market now. It is not for the "set and forget" crew. Focus on trades, apply discipline, and ultimately, just as a portfolio using stop losses would have disappeared to cash in a bear market, when the bull market returns, a series of successful trades will one day come together and your portfolio will miraculously reappear. On that day, you will look back and realise that without knowing it, you caught the bottom after all.

Regards, Marcus