Even though 2007 was a less than stellar year, I found it a bit disturbing when I realized that the market gave up all of last years gains in just the first 3 trading days.  Since that time equities have dropped even further with Tuesday’s declines pushing through what many considered to be support with very little respect for those levels.  Volume has been strong which gives those caught in long positions very little comfort and although the VIX is high (a measure of volatility that usually spikes close to a low point in a trading cycle), it is not close to the November levels and is even farther away from the levels seen late last summer.  So from many standpoints, it appears that we may have farther to go before stocks stabilize and mount any kind of sustainable rally.

Instead of crying over lost capital and complaining about the difficulties in this environment, a solid investor will take this time to step back and see what opportunities are being created.  This process will look very different depending on what style each investor has chosen to use for trading.  For those who are very short-term traders, the current environment is actually quite constructive.  After suffering through years of low volatility and tight average daily ranges, these traders now have ample opportunity to create real profits by correctly assessing the daily movement of stocks.  This brings higher risk levels and so leverage and position size should be properly adjusted so that one or two incorrect trades do not significantly reduce the capital available to trade.

For longer-term fundamental investors, the steep declines yield better entry points for those willing to be patient.  While there is little solace for those who are fully invested in long traditional equity positions, many wise fundamental investors have likely cut back on their positions due to the declining economic picture we are dealing with domestically.  For those with some cash on the sidelines, it can be exciting to see stocks we have confidence in trading at lower and lower prices as one expects that each lower tick creates a little more value when the decision is made to purchase quality companies.  Since 65-80% of an individual stock’s movement is dependent on the direction of the market (depending on whose statistics you trust), a declining market will create wonderful opportunities for those willing to do the homework to determine exactly how much of the price declines are due to perception that will eventually change, and how much is due to true changes in the economic value of the company in question.

When all the calculations and all the research has been completed, and the distracting noise has been stripped away, the successful investor will eventually be reduced to the fundamental building blocks of this profession.  These fundamentals fall into two categories that must be addressed in order to achieve success in most any business endeavor.  The two qualities necessary to remain on track in this environment are FOCUS and DISCIPLINE.

Focus pertains to the ability of one to filter out all the distractions and concentrate on the essential issues that create value.  In an age with instant messaging, light speed information flow, and access to mountains of informations literally at ones fingertips, it is very easy to be overwhelmed with “noise” and neglect necessary fundamentals.  So how does one go about creating focus in this distracting business?  For me, it means getting in to work a couple of hours before my associates in order to get quality reading and writing done with no phone calls or interruptions.  For others, it may mean turning off the email notification sounds on your computer, or even shutting down live quotes until a research report or conference call is completed.

The discipline side is uncannily simple.  One simply needs to have a plan – and stick to that plan.  So for active traders, a few specific setups may be the basis to nearly all of that traders gains.  This trader should be disciplined enough and confident enough to stick with the proven methodology and not try to create a new system just because a new trading idea has been profiled in the news.  For me, the discipline means holding cash when I really want to be making millions for my investors.  If the setup isn’t appropriate for the risk tolerance of myself and my clients, I need to have the discipline to stay out of the markets until the situation changes.  Alternatively, there are times I need to have discipline to stay IN the markets.  Often a position that has run 30-50% higher begins to tempt me to take it off the table.  In this case, unless there are fundamental reasons to believe the stock is overpriced, I need to have the discipline to stick with my original analysis and hold on until that analysis changes.

So back to today’s market – what can one do?  What am I doing???

At this point, I have one of the highest cash levels I have held in years.  There are a few select long and short pieces I have on, but these are very small positions and very few.  This does not mean that I am coming in to the office and watching Dr. Phil all day, but instead I am reading everything I can get my hands on that pertains to a growing list of attractive stocks I am looking at.  When the time comes for this market to turn, I want to have confidence to put some excellent positions on and really take advantage of the lower prices the market has given to us.  Until that time, I will continue to maintain a defensive position and enjoy the flexibility my fund has of holding cash until the picture becomes clearer.