Tuesday, April 29, 2014

Investing during a market crash

I haven't been blogging on my investments for a couple of weeks now. Other than the many company annual reports which filled up my letter box, the market has been rather uninteresting of late. My investments have been status quo with no additional buying or selling done.  Somehow I'm waiting for the market to go lower for more buying opportunities. If the market crashes, it's even better since i'm not even heavily invested in the first place.

Buying during a market crash may be the best way to make money in the stock market. But how many people actually dare to buy during a crash? During a market crash, there will be many negative news on the economy. Let me share with you my experience during a market correction. I would not classify this as a crash as its considered mild compared to a real crash.

This was during the year 2011 where there was a possibility of a huge economic crisis looming. First it started with Greece defaulting on its debt then it spread to other neighbouring countries such as Spain, Portugal, Italy, France etc. Some of these countries were the top few economies of the world and they were in trouble. Many economist predict something disastrous is going to happen. The US market dropped almost everyday with a 600-800 points drop on the Dow Jones Index on some days. I saw the biggest decline on the STI i've ever seen with a 100 points drop in a single day.

It is hard to buy any stocks when there is so much negativity. But those who did invest during these times would have made a huge profit and return on investment. It is therefore important to have a war chest(cash) on standby to take advantage during a market crash. How did these individuals manage to buy during times of trouble? I believe to have the courage to do that, we need to trick ourselves into buying and also have a clear strategy.



The trick yourself strategy

The main reason why people are not investing in times of trouble is because of fear. Fear is all in the psychology of the mind. You want to buy a stock but you may think whether this stock will drop further? The way to counter this fear of a stock dropping lower is to divide your capital into different tranche. Do not buy a falling stock at one shot with all your capital. Buy some first and buy the rest if it drops lower. But how to know at which level to buy and how much to buy?


Stocks typically drop around 50%-60% during a market crash

Typically, during a market crash, most stocks drop a maximum of around 60%. Of course this company must have strong fundamentals and a good track record of profits. A bad company can lose everything and go bankrupt during a crisis. Knowing the stock price of good companies drop a maximum of 60%, we can divide our war chest into 2 tranches to buy first at 30% drop and the second at 50-60% drop. Or we can divide our war chest into 3 tranches to buy the first at 20% drop, the second at 40% and the third at 50-60% drop. With this, we will always buy something during a market correction or crash and at least make a decent profit. It is better than trying to predict the exact low of the market and end up not buying at all which most people do. Many end up waiting for the stock price to go lower and scared that the stock price will continue falling. The psychology of this state of mind prevents one from buying stocks at a low.


Real life examples

Technical analysis can also be one way to guide us on our entry buy price. By looking at charts, we can know how much a stock typically falls during a market crash. Below shows the chart of the company called OCBC bank in Singapore. During the 2007 financial crisis, this stock fell from $9.45 to a low of $4.14. That is a 56% drop. If we had bought first at 30% drop which is $6.41 and second at 50% drop which is $4.75, the average price will be around $5.58. The stock recovered from the low of $4 plus to $7 plus in just 3 months. You would have made a profit if you dared to buy during the crash.

If we look at the year 2000 dot com bubble crisis, this stock also dropped around 56%. If we had used the same strategy, we would also have made a profit.

OCBC


Let's take a look at the next company, Singpost. This is also a stable company with strong fundamentals. In the 2007 financial crisis, this stock dropped about 53%. Applying the same strategy to buy first at 30% drop and the second at 50% drop, the same profit would apply. As we can see the stock price has already went above the high of year 2007.

Singpost


There are cases where the stock price of a company is cyclical in nature as seen in the company SIA(Singapore Airlines) below. This stock dropped 60% during the 2007 financial crisis. For cyclical stocks, we can still deploy the same strategy of buying in 2 or 3 different tranches but it will be futile to hold the stock throughout unless you invest solely for the dividends only. The stock price of these cyclical companies fluctuate up and down a lot and goes in a sideways fashion. Most of the time its better to sell it off for some profits before the next crash comes.

SIA


There are many other factors to consider when buying a stock and each stock may behave differently. This blog post would not be able to cover all strategies. By allocating our assets efficiently and minimizing our risks by diversifying into a few other stocks, we can all make some money from the stock market. When the market is all good and prices are climbing, always remember to stash away some cash (war chest) to invest during a crash. As the market goes higher, i actually lessen my exposure to the market and keep more cash. There will always be some form of correction which will allow us to buy stocks at much cheaper prices. I have prepared myself to 'trick my mind' into buying during a market crash. I know at what levels to buy and which stocks to buy when the time comes. Being prepared may be an edge to win this battle. Are you prepared for it?

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Related Posts:
1. Buying the company on the streets (Part 1) - Discovery stage
2. How to pick stocks (Part 1) - Economic Moats
3. Understanding financial statements (Part 1) - The income statement

21 comments:

  1. 1st half is to buy.

    2nd half when market recover strongly.

    To sell or hold? Now you will have to battle with both Greed and Fear at play.

    Two emotions. Can "tong"?


    LOL!

    ReplyDelete
    Replies
    1. Hi Uncle CW,

      Buying is hard but selling is hard too. Sometimes sell too early then miss out the rally. To hold takes courage.

      Delete
  2. Hi SGYI

    Is that first 30% drop and second 50% drop your personal strategy or are you just illustrating it as an example? In case if the stock drops 29% but because it did not hit your target and bounces up from there wont you have wished you would lower your band?

    ReplyDelete
    Replies
    1. Hi B,

      That's a personal strategy. However, my main poiny is to buy in at least 2 tranches instead of buying all at once.

      It is good to have a plan to buy at a certain price and stick to the plan. If it bounces up, then too bad.

      Delete
  3. Know buy is disciple. Know sell is shifu

    ReplyDelete
    Replies
    1. Hi cody,

      I guess both are important.

      Delete
    2. Brokers are likely to recommend Buy. Got Buy. Got Hope.

      Few brokers dare to recommend Sell. Why?

      Delete
    3. By the time brokers recommend buy or sell, most likely its too late already.

      It is hard to know exactly when to sell. We can only decide ourselves.

      Delete
    4. Why brokers always reommend u to buy? They are worried that u are not invested. Because that's their source of income. Watch wolfs of wall street and u will know :)

      Delete
    5. If sell so difficult, then don't sell - buy good dividend shares of well-run companies when cheap. Then hold long long for the growing dividends unless business fundamentals change (e.g. introduction of budget airlines into the air travel industry - at that time, I said bye-bye to SIA).

      Delete
  4. Well this is all about value investing isn't it?

    I have always advocate investing in shares during crisis times.

    That is the reason why I have not bought any shares for the last three years.

    Regards,
    SG Wealth Builder
    www.sgwealthbuilder.com

    ReplyDelete
    Replies
    1. Hi Gerald,

      Investing during crisis time is definitely value investing. Its all about buying good companies at undervalued prices.

      Delete
  5. focusing on seriously the wrong things. its not the magnitude of the drop but the frequency of the magnitude of the drop

    ReplyDelete
    Replies
    1. Hi Kyith,

      Hmm, I don't quite understand what you're saying. Are you saying the chances of a 30% drop is very rare? Maybe you can elaborate more on it?

      Delete
    2. I think what he is saying is that the frequency of a 30% drop comes in probably once on 5 years and a 50% drop probably once in every 20 years. What are you going to do in the meantime?

      Delete
    3. Hi B,

      Oh no, the buying at 30% and 50% is using the war chest. We can still invest In the meantime but always keep a war chest.

      Delete
  6. Thanks for the article.
    Informative and with clear instruction

    ReplyDelete
    Replies
    1. Hi investment in stocks,

      You're welcomed :)

      Delete
  7. Everyone said "catching falling knife" is dangerous.

    Why don't wait for the dust to settle down first and buy when it reverse trend?

    ReplyDelete
    Replies
    1. Hi RayNg,

      It is quite impossible to buy when it reverse trend. Nobody will be able to predict accurately when the dust will settle down.

      Like what warren buffet says: be greedy when everyone is fearful and be fearful when everyone is greedy.

      Delete