24 August 2012

How do I react when the market is in downtrend

How do you react when the market is in the downtrend?

To me, it is very simple, just "Buy and Hold" & "Portfolio Rebalancing". If you are long term investor, and you believe that there are still some valid reasons to hold the stocks / counters that you bought previously, then, do not be afraid to keep it and also average down the cost of investment.

Of course, you might ask me a question - "I have limited resources as most of my income comes from my salary, then how can I keep on pumping money in the down trend?" The money here I mention is meant for future spending purposes - Example your Retirement funds or Children Education funds. Do not ever try to make money from the emergency fund you would be using within 3 years. Basically a bear market would not last for more than 3 years, except for certain markets (e.g. Japan). You must be prepared mentally that do not OVER INVEST during peak time (I will explain to you what is the peak time in another article later). Reserve some cash for market crashes. You will be very happy if the market crashes happens one day later.

But how do we execute this strategy? In my experience, I would:

1. Switch Overvalued stocks to Undervalued stocks.

I have some experiences in switching counters, maybe we can call it "Pair Trading", means to Buy 1 counter and Sell 1 counter in the same industry at the same time. We may benefit from the widen gaps of the stock prices. Of course, be ready to do more comprehensive homework before you enter this "pair trade", as the counter you sell may rise further and the counter you buy may drop further, depends on the situation.

2. Use Cash to Buy stocks 

I always like cash. As the portfolio grows bigger, the cash portion would be meant for "emergency fund" and for purchasing assets purpose. It is always be more conservative when we invest in asset classes that will generate higher return compared to cash instruments. At this time, I may start reducing my investment in stock market and be ready for the bad times to come.

Mental strength is very important during the downtrend, especially when everyone around you will scream at you act like an idiot by buying a stock in downtrend. They will think that you are stupid guy because to them, they will tend to feel safer when the stock price is moving up, instead of moving down due to the "Loss Reversion" factor.

Be yourself, do not follow others. You may be wrong sometimes, but please stick to the investment philosophy that suits you most. Nice day.

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