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Dorn: What to Do Now?

Tuesday, 21 Oct 2008 | 7:42 AM ET

It is my opinion that we have not seen the bottom in these markets. There are still many unknown factors out there, and there will most certainly be surprises both in terms of earnings, further deleveraging and more tinkering with our financial system from the government.

Right now, there is a new bailout package being discussed, so we can expect more uncertainty and volatility to come. That said, we are now in the seasonal and price pattern for the markets to at least stop going down for a while. In fact, it is possible (as I have written in my blog posts) that we could slog our way up for the next weeks and even into early 2009.

There will be down days, and that is where the psychology will be important to understand. There is more about this below.

But first:Encouraging signs that the worst is ( temporarily) over are:The markets are bouncing today from oversold conditions. This does not necessarily mean anything in a bear market, because oversold conditions can remain so for considerable periods of time while everyone is trying to call a bottom and getting stopped out.

However, it looks more promising now than it did last week for a short term bounce that could turn into something more. The drop in LIBOR , the rise in 3-month T-bill rates and the fall in Eurodollar rates. This means that the TED spreads are narrowing and is likely the beginning of a healing process for a badly-injured credit market. It is a ray of hope, but certainly the patient is still in intensive care.

Also, the VIX is pulling back from its lofty levels, indicating some market stability and less emotionality. I received warnings over the weekend from three internationally-known newsletter writers calling for a major crash today. That was enough to get my attention for sure!

The calls I have been receiving and the hits on my Web site (www.thetradingdoctor.com) have picked up enormously since last Wednesday. That is another indicator I use to tell me that we are close to being out of the murky mess.

Several market psychiatry factors must now come to the forefront for both traders and investors:

1. If you have not learned the lesson that buy and hold is recipe for disaster in this type of market, I don’t know when you are going to learn it. Please go back, review what has happened to you and ask yourself if you want this to happen again. If you are down 20-50%, and waiting for it to come back, I have concern. It is likely that you may also have concern because the probability is pretty good that it will not come back for the foreseeable future. This is not to say that core positions are out. There are solid core positions with reasonable dividends that will serve you well at this time. I recommend at this time a core position of 30-40%. The remaining 60-70% is for trading.

2. These are trading markets where the ability to execute without emotion is the key to success. In other words, it is important to adopt a trading, rather than an investing mentality.

3. In order to trade, you must have money. If you have lost 20-40% or more, you may not have money to buy into any downages and sell into any rallies. That is why it is important to preserve capital—so you can play another day. At this time, those with the most cash to deploy are best positioned. This is why we recommended in October of 2007 to get out of all underperforming assets and begin raising cash.

4. More than ever, you must train your brain to think counter intuitively. I have been speaking and writing about this for many years and it is now more critical than ever. What this means is having the courage to step up and buy on downage and sell into uppage. The majority of people are hard-wired to do just the opposite. This means being greedy when you feel fearful and vice versa.

Word on the Street
The Fast Money traders take a look at today's top business stories. They're joined by Dennis Gartman, founder of The Gartman Letter.

5. Learn to take high probability trades and to honor all stops. If you are trading without stops, it is akin to driving in freeway traffic blindfolded and without brakes. Due to the daily swings, you are likely to find that stop placement needs to be reassessed in order to adjust for the still-elevated volatility and real possibility of whipsaw.

6. Please read and re-read Dennis Gartman’s Rules of Trading and my behavioral annotation of Mr.Gartman’s rules. They are never more valuable than in this type of environment. (See some of Gartman's recent comments in the video)

7. Remember to always trade what you see, not what you think you see or believe you will see. Hallucinations and delusions can be quite prominent in the stage of what is called rapid-cycling manic-depression. The markets have shown us the violence of this type of psychosis. Let us now allow them to take some lithium or tegretol, and—perhaps—settle down for a bit.

What are Other CNBC.com Guest Bloggers Saying ...

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Janice Dorn, M.D., Ph.D., is a financial psychiatrist and chief global risk strategist for Ingenieux Wealth Management in Sydney, Australia. She also offer trading consulting and coaching services via her Web site, TheTradingDoctor.com.

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