One of the most important lessons that a successful stock investor needs to learn is that there are times when the market is presenting plentiful, low-risk opportunities and there are times when making money in the markets is quite difficult and far less certain. Adjusting one's strategy for these different market environments is key. You can trade aggressively in a terrific market environment and make triple-digit annual gains with ease. But trading just as aggressively in a very difficult market environment could result in a huge drawdown of capital. Remember that a 50% drawdown erases a 100% gain, and requires a 100% gain just to get back.

Over the years, one of the most common stories I've seen is for a smart investor to begin investing very aggressively during a strong market run-up when the environment is fairly easy pickings. This smart investor will have a strategy that exploits the good environment quite well -- and he'll typically make huge gains of around 500%-1,000% on his money in a one- to three-year period. But when the market environment changes, this investor refuses to change with it, and in the following one- to two-year period, the investor loses most or all of his trading capital. Witness Foxhound funds' recent wipeout -- a leveraged 300% gain in 1999, but a total 100% loss of everything by April, 2000.

Clearly, learning to understand when one can be aggressive, and to understand when to be defensive is important to investors desiring to maximize gains with minimum risk.

We've already discussed (in prior lessons and courses available on TradingMarkets.com) some macro tools investors should watch -- like interest rates, market breadth, and timing models both short and long-term -- to help distinguish an environment conducive to aggressive vs. defensive trading. In addition, investors should watch carefully the number of flag and cup-and-handle breakouts or breakdowns in stocks with upfuel or downfuel to see how abundant the market's opportunities are.

Probably most importantly, investors should watch carefully our daily list of Top RS New Highs (on TradingMarkets.com) and the groups and sub-groups based on this list as well as the Bottom RS New Lows and the groups and sub-groups based on it. When the list of Top RS New Highs is more than 20 stocks every day and there is clear leadership in several groups that are broadening with more and more new highs in that group each day, the environment is more conducive to aggressive buying. Conversely, when the list of daily Bottom RS New Lows is more than 20 stocks every day and there is clear downside leadership in several groups with more and more new lows in those groups each day, the environment is conducive to more aggressive shorting. When Top RS New Highs and the number of issues in leading groups thin out, the environment is one to become defensive toward on the long side. And when the Bottom RS New Lows and the number of issues in lagging groups making new lows thins out, the environment is one conducive to becoming defensive toward the short side.

Until early March 2000, both the short-side and the long-side showed broad participation and seemed to be indicating an aggressive posture. However, beginning in very early March, the environment began to change abruptly. Top RS New Highs began to thin out to under 20 issues and the leading groups began to show fewer and fewer new highs. Similarly on the downside, Bottom RS New Lows began to thin out to under 20 issues and the lagging groups began to show fewer and fewer New Lows. This is why, in early March, when we had been previously advising fully leveraged shorts and longs, we advised investors to take half profits on all positions. Leadership was failing and the opportunistic environment was at a sea change.

Since early March, the stock market environment has changed. There is no clear leadership on either the upside or the downside. In addition to reducing leverage, tightening up trailing stops, and taking 1/2 profits on all positions, investors need to trade more defensively in their approach going forward until a better environment returns.

In future lessons, we'll discuss a number of ways of becoming more defensive while still leaving ample room for profiting from market movements. But a huge part of knowing when to trade aggressively and when to cut back is revealed simply by watching carefully the breadth and number of flag breakouts and cup-and-handle breakouts to new highs in stocks with upfuel on our Top RS New Highs list -- and in watching the leadership and breadth of stocks and groups on these lists over time. Similarly, a huge part of knowing when to trade the short side aggressively or when to cut back is revealed simply by watching carefully the breadth and number of downside flag breakdowns and downside cup-and-handle breakdowns to new lows in stocks with downfuel on our Bottom RS New Lows list -- and in watching the downside leadership and breadth of stocks and groups on these lists over time. These lists are some of the most incredible tools available to investors anywhere.

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