The recent events in the markets reminded me of a great tip from the legendary investor Stanley Druckenmiller. For those who don’t know him, he averaged 30.4% return per year for 30 years with not even a single negative year.
In an interview he was asked about what made him so successful in the markets and his answer was:
“Having an open mind. I never get married to a position. I’ve had positions where I was sure I was going to hold them for 2 years and a week later I didn’t have a position and I was short. Because conditions change. If conditions change, you have to move immediately. That was true 20 years ago and it is 10x now with the internet and everything.”
To explain this concept better, I will use a recent example with the Nasdaq (this is of course hindsight analysis but it's good for educational purpose).
Last Wednesday, after a strong selloff caused by the deleveraging of the Yen carry trades, the market started to bottom out going into the BoJ decision. At one point it looked like the worst was behind us as the Nasdaq broke through key technical levels and rallied almost 5% in a single day.
Unfortunately, the following day we got an ugly ISM Manufacturing PMI which sent the market into risk-off and defensive positioning into the NFP report. The US Jobs report worsened everything as the data surprised to the downside with unemployment jumping to a totally unexpected 4.3% rate. The losses extended and eventually we got a strong overnight selloff yesterday as the Nikkei crashed 12% in a single day causing a global market rout.
In the bigger picture, there were certainly good reasons to expect a rally last week and eventually even a new all-time high. But we can see from the chart above that the ISM Manufacturing PMI was the catalyst for the selloff, and once the price fell back below the key 19400 zone, the bearish momentum increased.
In that case, conditions changed.
This is when you should take countermeasures to protect your capital.
You could have closed out a long position altogether or you could have reduced your risk if the conviction in your trade remained strong. In any case, it was the time to adjust and not getting married to your original idea.
