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Importance Of Controlling Risk In A Choppy Stock Market

|Includes: DIA, IWM, MDY, PowerShares QQQ Trust ETF (QQQ), SPY

When the stock market is in a strong, multi-month rally, it usually takes five or more "distribution days" (broad-based losses on higher volume) to end the momentum of the uptrend. However, when the main stock market indexes have only recently registered a fresh "buy" signal off the lows, just one or two days of higher volume selling ("distribution") within one week of the new buy signal is all that is needed to kill the attempted rally. With yesterday's (July 10) heavy volume selling, the Nasdaq Composite has already printed two "distribution days" since its recent buy signal, thereby forcing our disciplined, rule-based market timing model back in to "sell" mode.

Nasdaq Volume

Obviously, we would have preferred stocks and ETFs to have surged higher over the past few weeks, but there are some incredibly important lessons to be learned when a rally attempt fails.

New traders and subscribers of our Wagner Daily swing trading newsletter should focus on how we leg in and out of the market with both buy and sell signals when they are so close together in time. Although we can not change the price action of the stock market, one thing we can definitely control is risk. The manner in which we carefully manage swing trade positions in a tricky, indecisive market is TEN TIMES more valuable to new traders/subscribers than how we manage a winning trade in a bull market. Put another way, everyone is a genius in a bull market because one can just throw a dart and probably make a hit. But the way swing trades are managed in a challenging, choppy markets such as the current environment always determines whether one holds on to previously earned stock market profits or gives it all back due to churning the trading account.

A trader must continually be digesting market action and be willing to go with the flow -- doing nothing and staying in "hope mode" with trades not working out is never the answer. The key to our consistent, long-term profitability has always been to lose only a little when wrong, so that we avoid digging too big of a hole, which ensures we are mentally in good shape to catch the next big rally. Lately, there has been very little reward for the risk of being long. As such, we feel it's best to be positioned primarily in cash while waiting for the market to make up its mind and settle into a new trend in either direction.

To learn more about our disciplined risk management procedures in both choppy and steadily trending markets, sign up for your risk-free trial subscription to our swing trading newsletter.