3 Steps to Navigate the Rough Markets Ahead

Look at the market's wild five-year ride:


Source: Capital IQ, a division of Standard & Poor's.

All of those ups and downs have left many investors with nothing but an empty bottle of antacid. And according to a study from Morgan Stanley, following a bad bear market, markets remain volatile for five to seven years.

Ugh. Three to five more years of ups and downs. What's an investor to do?

It's time to take control
Times have changed. This isn't 1982 to 2000, where the rising tide of a long bull market lifted all stocks. I think multibillionaire hedge fund manager Paul Tudor Jones sums it up perfectly: "Adapt, evolve, compete, or die."

No one wants their portfolio to die. So it's time to adapt, evolve, and compete. How? With a stock-picking plan that fits the environment:

1. Find the strongest trends.

2. Determine the best trades.

3. Only bet with the odds.

First, let's take a quick look at each step of the plan. Then, I'll show you how to follow along as I use this strategy to manage my "Trends and Trades" portfolio in today's volatile environment.

The trend is your friend
Trends, both big and small, are everywhere. Here's one that's gaining momentum. The price of natural gas is stuck at the bottom of the well. Many domestic energy companies are shifting their focus to oil, setting up some lucrative opportunities.

EOG Resources (NYS: EOG) is leading the change. Management expects its 2011 production to be 70% liquids and 30% from natural gas. That's a 180-degree shift from 2008. EOG Resources' big oil push is paying off as profit continues to grow in 2011.

SandRidge Energy (NYS: SD) sees the benefits of black gold, too. As of Aug. 30, 2011, all of its rigs were drilling for oil. That's a major shift in the company's strategy. In 2008, 88% of its production came from natural gas. In 2012, that figure should drop to 43%.

Both companies are switching strategies for the same reason. The economics of drilling for oil are more attractive. That's why I've added both of those companies to My Watchlist.

Trading is not a dirty word
A trade is simply the purchase and sale of a stock. Whether we hold the stock for two months, two years, or two decades, we trade stocks. Many investors prefer to buy and hold stocks. But in today's volatile markets, that may not be enough to grow and protect our portfolios.

lululemon athletica (NAS: LULU) continues to profit from a trend it created: yoga-inspired clothing. It is arguably the best retailer on the planet right now, 16% comp growth and a jaw-dropping $1,800 sales per square foot. The stock has certainly run up, but I think there's still money to be made. If I purchased shares at today's prices, I would consider selling into any big advances to protect my profits should expectations get too high.

Contrast Lululemon with Dangdang (NYS: DANG) , which has been hammered since its IPO. E-commerce is going to be big in China. The company may be growing fast, but it is very young and competing against bigger, more established players. I may not be ready to buy shares today, but I'd take a more buy-and-hold mindset with Dangdang.

Buy and hold is one investing tool. And it's a good one. But not being willing to trade could put our portfolios in danger. Today, trading is not a dirty word.

No gambling allowed
Like you, I invest to make money, keeping score with absolute returns. Beating the market is no consolation if my portfolio is in the red. And investing when the odds and payoffs are in our favor is the best way to keep them in the black.

Bank of America (NYS: BAC) continues to hog the headlines. Warren Buffett recently injected $5 billion worth of capital into the bank. Is it time to buy shares? I have no idea. First, Buffett didn't buy common equity. Second, a price-to-book ratio of 0.4 may look attractive, but only if I am confident about the value of the assets on the balance sheet or I can get a sweet deal like Buffett. Since I can't be sure about the assets and don't have the negotiating power, I'll pass.

Bank of America is too complicated for me to reasonably assess the odds. I understand Apple's (NAS: AAPL) balance sheet and business model better than Bank of America's. My research shows Apple is selling more Macs, iPhones, and iPads and the average price per unit is increasing. Throw in $75 billion of cash on the balance sheet and P/E ratio of 15, and the odds of success look good.

The perfect plan
The stock market has recovered nicely from its low in March 2009. Unfortunately, the U.S. economy is slowing down again. There's no political will for additional stimulus and fear is creeping back into financial markets. Odds are good that volatility is here to stay. That's why my plan is to:

1. Find the strongest trends.

2. Determine the best trades.

3. Only bet with the odds.

I am going to use this approach to grow and protect the capital in my "Trends and Trades" portfolio. I expect it to pay off handsomely. So you won't want to miss any of the action. To stay up to date with all the research and trades, simply click here to follow along on Twitter at @trendsandtrades. It's simple to use and best of all, absolutely free!

At the time thisarticle was published David Meier is an associate advisor for Million Dollar Portfolio and owns shares of Apple. The Motley Fool owns shares of Bank of America, Apple, and lululemon athletica.Motley Fool newsletter serviceshave recommended buying shares of lululemon athletica and Apple.Motley Fool newsletter serviceshave recommended creating a bull call spread position in Apple. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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