Investors were worried with the recent stock market ‘correction’. Some fearfully sold their stock, but have hesitated getting back in. Now, the ASX200 has rebounded more than 70% of the decline, and if you weren’t active in the markets, you have missed most of the rebound.
Last weekend I spent two days with nearly 50 clients at a conference discussing strategy and market activity. It is always invigorating taking that time out, away from the desk and out of my box, to get a real world perspective. Although my day to day activity is spent analysing, finding trade opportunities, crunching the numbers and relaying those to clients, the picture I see as a professional is detached from how my clients see the markets.
The ASX200 index has recently undergone a 9.8% decline from its August peak to the recent October low. This is just shy of a technical “Stock market Crash” of 10%, and having broken down to 8-month lows, has had investors exceptionally concerned.
My analysis of trading is a less emotional approach. Don’t get me wrong, I feel the elation of a profitable trade and the gut wrenching illness brought on by a loss trade. But I also have more than 15 years experience in trading stocks, options, CFDs, currencies, and futures contracts. Of the lessons I have learnt in that time, one particular lesson comes to mind: You will not make a fortune in one single trade. It is the consistency of a sound trading approach that will create success over time.
Strategy is the key to surviving a stock market crash
If our positions had not already triggered their profit targets in the run up to the stock market high, our exit strategy was in place ahead of the reversal. In fact, we don’t enter a position unless we have a defined exit approach for all the various situations that might arise. Including, declining stock prices, stock market crashes, or even positively induced gapping in the share price.
As the stock market declined through September and into October, our Covered Call positions were either being closed, or we were monitoring our exit levels. Once breaking into new lows, we had very little exposure to the stock market at all, alleviating the risk that the correction might turn into something a little more serious, such as a crash.
Now, the real trick to management of your portfolio is that you need to be getting back into positions as soon as sentiment starts to turn. I’m not into the strategy of trying to “catch a falling knife”, so this can take some experience in defining change back to buyer psychology. But there are some simple methods you can adopt to assist you.
Apply a simply 50-day moving average approach, or for longer-term investing, a 100-day moving average. This method, which you can search through our website for related articles, is the simplest method in analysing trend. It’s not infallible, but if used consistently is better than taking a punt at what you think the markets should be doing (that is, Hope and Pray!).
No-one can predict the markets
In late October the markets started to rally. However, with 2 or 3 days of upwards activity, how was anyone to know that this was the start of a sharp V-shaped rebound? The answer is; no one could. It was about a week into the rebound when the ASX200 index broke the downwards trend that had resulted in a 9.8% decline from the recent high.
At this point, our portfolio management was to slowly accumulate positions to build up our portfolio. If we were to jump in warts and all, we would be at risk of exposing the entire portfolio capital to a potential Bear market. Hence, we slowly added positions and as the markets continued improving, we had exposure to the recovery.
But if you were too fearful of the recent market decline, you probably sat on the sidelines. If you panic sold your shares (probably at the bottom), you are now sitting there looking to buy back in, having missed the majority of the recovery.
This is typical activity from investors, and a scenario we see all the time.
What do you do now?
If you have missed the rally, you can continue to build your portfolio buying on the dips. Of course the million dollar question is whether or not this market will continue pushing into new long-term highs, or start to stall again. Reality is that no-one knows what will occur for the remainder of the year, so we need to be smart about our strategy approach.
Only enter positions knowing where you will exit if it all turns to custard. That is, have a plan. And not something that is “I want to make money!” If the markets continue to rise, you can look to add new positions. When the markets eventually top out again, as they inevitably will, by having a plan you will start to exit positions.
The old school method of buy and hold, riding through the market corrections or crashes, and maintaining a portfolio for the long-term is fine, but does not meet the needs of all. My professional opinion is that by adopting some sound management principles, you can decrease your exposure during periods of seller infliction, and rebuild on the way back up. In this way, you will avoid those big stock market crashes, be cashed up at the bottom, and be ready to accumulate as buyers return.
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