In a volatile market, short-term stock trends can be used to control risk and enhance returns. The amplitude of short-term price swings is often greater than a stock's appreciation for a full year. Since a person cannot know in advance whether a short-term "dip" will not become a "plunge," it is necessary to pay careful attention to the dips, and to set limits to how much of a decline in stock price will be allowed before selling.

Investors have been dragged kicking and screaming to the realization that buying good quality stocks and putting them in a safe for 5 years is not the way to obtain great returns in the market. That can work with a good mutual fund (if the manager is a good stock-picker who has a good sell discipline), because the manager performs the necessary buying and selling while the investor simply stays put and waits. Though a person might do well sitting and waiting for a mutual fund to perform, sitting and waiting for individual stocks no longer works as well as it once did. On average, the buy and hold approach could net an investor market-level returns or slightly better (market returns range from 7% to about 11%). What's wrong with that? We must ask ourselves whether that kind of return is worth the risk. We have seen the devastation that can result from this approach in a severe bear market or sudden crash. Unfortunately, we do not have unlimited capital with which to work. For most people, preservation of capital is the prime directive. Let's clarify what this statement really means. If we say that, "preservation of capital is most important," and then we buy stocks and hold them through their ups and downs, we are not acting in accordance with our stated belief. Acting according to our stated belief means we have to place limits on the behavior of each of our positions. What does this mean in real terms?

One fact that has to be dealt with is that a few years ago the typical "trend" of a stock lasted about 6 months. This was the approximate "central tendency" of the distribution of trend duration measurements, meaning that some trends were shorter and some longer. The curve of probability is skewed because sometimes a stock will trend for well over a year. Recent volatility appears to have shortened the duration of the typical trend. Even if this were not so, there is no way to know in advance which stocks will trend for a year or more. Therefore, to preserve capital, we must be prepared to pull the plug on a position at any time. In other words, issues other than the length of time that we have held an investment must be the deciding factors as to whether we continue to hold or sell. A poor earnings report, the death or retirement of a great company leader, war, a new competitor, and acts of terrorism are all factors that can influence stock behavior. Market behavior tends to anticipate non-random events (insiders, friends, competitors, and other associated persons and their observers often know how companies are doing before those companies release public statements, and all these people buy and sell stock). Thus, changes in the price and volume activity of a stock often precede the news releases and earnings adjustment reports.

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