Brian Shannon on Bear Market

Let me repeat the mantra that using P/E, cash flow and other fundamentals can be harmful as crucial trading determinants in a downward market. During downtrend, hope tempts market participants to look at these traditional measures of valuation to justify establishing a long position. But only price pays and the message of declining prices says do not buy. In a bearish environment, these valuation tools will drop much lower than most people expect, then revert back outside the mean. Price is the only objective measurement of value, and as perceptions change, prices and valuations change.

Another temptation is to get long a declining stock because you feel the stock is “down too much”. This thinking is based on the hope that sellers will “come to their senses” and recognize the value. They won’t. Logic and reason get thrown out of the window when participants act on emotion. Recognize that a stock in a downtrend will bring about those emotions at quick to sell at first signs of trouble. A stock is never down too much when there is a simple absence of demand.”