I haven’t written much about the recent stock market draw down, more or less because in recent times I tend to be a little bit more passive about it. However, perhaps I can provide some thoughts at this current juncture and what might be running through some of your heads.
At its highest, the STI Index reached 3549 and currently it hovers around 2950, bringing the total drawdown to be 16.9%.
I do not know what causes this
Many have asked for an explanation of the exact cause of this fall. I have to admit I have no idea. I am not smart enough to deduce it. If I were to guess, a lot could be due to fund flows being pulled out of the country. Singapore, being a small market, do see external fund flows in and out of the market, and this tends to cause rather large changes to the stock market.
A stronger USD, or a flight to safety of the treasury bills could be a reason as well.
The bid and ask spread gets larger and larger
One aspect that may have caught a lot by surprise is that the spread between those that want to buy and those queuing up to sell have been rather different from normal times.
You would think you can exit the stock market at the best price. However, the buy queue have less people queuing and the sell queue have a lot more. People can afford to bid to buy at the price they want because they are not afraid of missing out since, not many have the guts to buy. The sellers, just want to offload as fast as they can to cut their psychological pain at any price.
The effect of this is the price spiraling downwards.
You are at a lost what to do when a lot of your stocks are red
One week, you were sitting on unrealized gains. In one short week, you are staring at unrealized losses. Suddenly, what was a ‘good long term’ investment suddenly looks very questionable.
You have set out a price target of $XX. Now this totally changes. What would you do? Hold on? Will it rebound? Maybe you will wait for the next rebound to get out.
Everything is falling but at this point, what is attractive?
What you wanted, which is that things are not so ‘expensive’, have finally came. The mood is totally not what you anticipated. Every thing just went down in one direction. What is a good stock to buy now? What is a good price for the stock?
Suddenly you realize that judging only based on price doesn’t really help so much. This is because you cannot tell much based on the ticker price.
Much of the problem here is that, the work to evaluate stocks should have been done even before the price move up or down.
The competency required to evaluate well should also have been built up before the price move up or down.
It is time to see whether your strategy is foolproof and if it works
All the stuff that you learnt in courses, books about setting stop losses, what you should do when price hits a certain range down, leads to this.
This time it is real and whether those theory and scripts work or not will be in full display to yourself.
Or perhaps, you do not have a script or a strategy for when stock prices go down but only when prices go up?
If things doesn’t work out, then you pay the tuition fees to Mr Market for teaching you this valuable lesson. In some cases the tuition fees can be massive.
Your brain keeps telling you that you can get stocks cheaper
You have stocks you hold on to and in the face of falling prices, the devil on one of your should keeps telling you that you look like a vegetable head for having this stock at this price while EVERYONE else is buying them at lower prices.
Or that, you have done the sound thing of buying in the stocks at a lower price, but the price drops even further, so the devil on the shoulder tells you that prices can get lower still.
So you should sell and wait to buy back lower.
You pat yourself on the back for selling and being in 100% cash. You seem to know very well how long this market will fall and how much it will go down by. Why fight the trend?
Only for the market to head straight up
This is probably what happened in 2011. There are much folks that, still remembering well what happened in 2008-2009, was sure there are more to come after a 14% fall.
The turn at the start of 2012 was swift and relentless.
Suddenly, you realize that you didn’t buy much!
Then again, the fall may take place over 3 years
In another case, just when you thought the recent resumption is only 1 year, Mr Market decides to give everyone something similar to 2000 to 2002, where the market fell in very ‘manageable’ 25%, 25% and 15% over 3 years.
The magnitude of the fall is one thing, but the psychological drain over 3 years, the many false dawns, are what make that bear market difficult to navigate.
If your portfolio is small, you should be glad about this
Whatever lessons learnt now will help you in the future, but only if you lean the right lessons.
Think ahead that if your portfolio is $25,000 and that, in the worst case scenario it is halved, you would have an unrealized loss of $12,500.
If you have a good wealth system where you put $12,000/yr recurring into your wealth fund, whether this drags on for 1 year or 3 years, you get to accumulate at lower prices.
The loss of $12,500 is an indicator that prices are much better. If this drags on for 3 years, you have MORE opportunity to accumulate $36,000 at perhaps seldom seen prices.
Visualize that, in 10 years time, your funding to your wealth fund to be $120,000 and a loss of 50% of $12,500 do not look so bad after all.
Pace yourself well when investing
It is difficult to have a systematic plan to buy, without knowing the duration and magnitude of the drawdown.
I thought what Morgan Housel presented provides a good rule of thumb based on the frequency of occurrence and magnitude to size how much to invest.
However, realize that he is referring to general index investing.
For individual stock investing, you could use how much the general index have fallen by, as a yardstick to start investing. However, you still have to evaluate each stock on their own.
If you buy in the same duds, you will eventually still end up with duds.
That often forgotten wealth building model called Wealth Psychology
When things are well, not many would have bothered with this behavioral aspect of investing. Most would think that they are well equipped to handle what Mr Market throws at them.
Even if you read up extensively on it, to suffer and feel it can be very different.
You just do your best to prepare your mental state for it, set up your wealth system to factor in this aspect of it and hope for the best you do not crash and burn.
A lot of it comes from experience, but also reading up on our cognitive bias, our deficiency as human beings.
Some of my past write-ups that might be helpful
- Waiting for a market correction. What is your action plan?: Stock market corrections can feel frustrating to wait for but they will come around. Focus on your plan when it does.
- Distress Stock Buying. Your favorite stock plunges. What is your plan?: Your favourite stock plunges, when do you buy? How do you know that is the right price to buy?
- Correction or not, make sure your process is sound: The market can gyrate, and that you won’t know where the market goes, but what matters is a sound plan when both up and down happens. A good simple action plan by Morgan Housel as well
- Preparing for the Recession: Stocks and Asset class setup recommended by David Rosenberg that an investor can divert into to prepare for a recession.