Fear Holding You Back? Here's How to Trade with Conviction...

Oil’s greasy mitts are yanking the major averages all over the place these days…

Friday’s big crude and stock rally is now fading on both fronts. The S&P 500 finished trading down more than 1.5% to start the week, while light crude has settled down near $30 once again.

This devil’s dance between equities and crude is reviving a bull market of a different sort: a bull market in ink. Lots of the stuff is being spilled over whether oil rebounds or goes to zero, and which scenario is better for the economy.

None of this noise does you any good. So instead of getting whiplash watching the debate, prepare for how you’ll react once the market give the all-clear signal.

One of the ways you can weather the storm is by curating a potential buy list during the market drawdown. This is a strategy I’ve plugged all month while stocks have found lower ground.  Today, I’m giving you 3 rules of thumb to help you assemble that list.

Your list should consist of quality stocks you’d like to own over the long run that are currently getting the snot kicked out of them. You can check in with these stocks once a week for signs they’re bottoming.

Why spend the time and effort to make a list of once-strong stocks that are flaming out?

Let me explain…

Pull up a long-term chart of any stock that’s posted impressive returns over the past few years. Looking back, you might think it was a flawless run higher.

But you know that’s not true. The long-term trend leads you to ignore the big pullbacks that shook out so many investors along the way.

Hindsight’s a bias you can’t escape. We think it’s easy to cash in on the trends pictured on the charts we pull up on our screens every day. And that’s where we run into big trouble.

In fact, if you pull up any long-term chart of a home run stock, you’ll find more than one huge drawdown that accompanied the rise that delivered massive returns.

Just look at the 10-year performance of Apple Inc. (NASDAQ:AAPL). Apple has been one of the best stocks to own this century. Since early 2006, the stock has returned nearly 1,000%.

But it faced some nasty dips along the way…

10 Years to 1,000%

The financial crisis pelted Apple with a 60% loss in about 12 months. Another big drawdown cost investors a cool 45% in 2012-2013. Don’t tell me you would have held Apple stock through these two major drawdowns without breaking a sweat. I’m not buying it.

But you’d be crazy to ignore a long-term winner like Apple because it didn’t jet higher in a perfectly straight line. That’s why you have to make sure to enter these plays with the correct mindset. If not, you could end up with poorly-timed sells that cause you to either miss out on a much larger run or give back hard-fought gains.

So to help combat your emotions and get you into the right stocks when the big opportunities arise, here are some thoughts to keep in mind when developing your own system. Use them to plan your next long-term conviction trade:

Pick a viral theme.

Large, well-known stocks in popular or upcoming industries work best for longer-term ideas. Your trade needs to be easy to understand. You should even give it a solid barstool pitch before it passes the test. If you can’t convince a buddy at a bar that the idea makes sense, you should scrap it. (Just make sure you’re both relatively sober).

Define your exit strategy before you buy.

Forget about short-term moving averages. And don’t get hung up on selling your trade at the perfect moment. It’s never going to happen. All you need is a pre-defined exit signal to keep you from second-guessing yourself or making an emotional trade. And yes, that means you’ll have to endure a little pain along the way.

Under Armour stock significantly violated its 50-day moving average more than seventimes from 2013 until it peaked last year. Shares jumped from $22 to $78 over that period (split adjusted). You should consider something closer to a 200-day moving average or other longer-term trendline instead. 50 days isn’t enough for a long-term conviction play.

Don’t pinch pennies near the bottom.

Don’t be such a wimp just because the market cratered. Stocks can zoom off their lows in a heartbeat. Get over it and hit the buy button once your idea sends strong breakout signals. If a potential long-term trade is up more than 5% on the day, one of the worst things you can do is to put off buying.

The correction will offer you a sweet discount on shares. Once a stock on your list reverses course, you can’t get greedy and wait for a short pullback that might never come. The best stocks aren’t going to sit around waiting for you to get in a couple of bucks lower. If you have a system in place, it shouldn’t bother you if a longer-term trade isn’t in the green right away.

That should get you started. I’ll continue helping you build out your buy list as the correction persists. Treat these big pullbacks as gifts and the market will eventually reward you for your efforts…

Now start making that list!

Greg Guenthner
for The Daily Reckoning

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