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Adjusting Your Trading Strategy During Volatile Markets

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Stock selection is important in all market environments, but it really comes to the forefront when stocks are falling. During swift corrections and painful bear markets, all investors would happily choose a stock that is rising over a stock that is drastically falling.

The question on investors’ minds now is – are we entering a prolonged bear market or is most of the pain already over?

The 2022 bear market has undoubtedly been one of the more difficult market environments to navigate over the last several decades. The volatility has frustrated both bulls and bears, as the whipsaw action has made it problematic to profit from either the long or short side.

But traders who are able to adapt their strategies to the volatility can still reap substantial profits. When most stocks are falling, it’s common sense that profits will be smaller than normal and losses will be larger and more frequent. There are a few ways we can lessen any potential downside impact and adjust our strategy to the more volatile environment, including:

-Sizing positions less than normal, resulting in less capital commitment. Less capital at work means less overall risk. While holding cash in a highly inflationary environment isn’t ideal, it’s better than holding stocks that are falling 20-30% in value or more.

-Tightening up our stop loss/selling target. Using a rule-based system that eliminates emotional decision making can help us avoid large drawdowns. We can also adjust the parameters of that system according to the type of market dynamic. In more volatile markets, perhaps we adjust a normal 10% stop loss to 7-8%.

-Taking profits more quickly than normal. Due to the inherent volatility during bear markets, rallies tend to be shorter in length, and as such we must be willing to take profits sooner than we normally would.

Regardless of your individual market approach to investing or trading, there is only one way to protect your portfolio from a large loss. Selling at a small loss before it snowballs into a large loss is the only way to ensure a devastating drawdown does not occur within the context of a portfolio.

The most important thing during bear markets is avoiding the big errors. We want to have a plan going in that will help guide us when the market tests our resolve. The stock market has a way of proving the majority wrong. Making investors feel unwise is the market’s way of pressuring them to act in a foolish manner. It’s essential to remain disciplined and not deviate from our strategy.

In this type of volatile market environment, new long trade initiations should be kept to a minimum and targeted only toward the top-performing industry groups and individual stocks. If the market turns back up, we can become more aggressive. We let the market guide us instead of trying to predict what will occur.

On that note, targeting leading industries for long positions is the first step to identifying individual stocks that are set to outperform the market. The Zacks Outsourcing industry is currently ranked in the top 13% out of more than 250 industry groups. Because it is ranked in the top half of all Zacks Ranked Industries, we expect this group to outperform the market over the next 3 to 6 months. Also note the favorable characteristics for this industry:

Zacks Investment Research
Image Source: Zacks Investment Research

By focusing on top stocks within leading industry groups, we can dramatically improve our trading results. Let’s take a look at a top performer within this industry.

Automatic Data Processing, Inc. (ADP - Free Report)

Automatic Data Processing is a global provider of cloud-based human capital management solutions. Its offerings include payroll, benefits administration, talent management, as well as insurance and retirement services. Automatic Data Processing was founded in 1949 and is based in Roseland, NJ.

ADP has exceeded earnings estimates in each quarter for the past five years running. The company most recently announced fiscal Q1 earnings back in July of $1.50/share, a 1.35% beat over consensus estimates. ADP has delivered a trailing four-quarter average earnings surprise of 5.02%, aiding the stock’s 20% return in the past year.

Zacks Investment Research
Image Source: Zacks Investment Research

For the current fiscal year, analysts are projecting earnings growth of nearly 15% to $8.05/share. Sales are expected to increase 8.36% to $17.88 billion. It’s obvious the growth is there and looks set to continue.

Zacks Investment Research
Image Source: Zacks Investment Research

Make sure to put ADP on your watchlist if you haven’t already done so.

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