Skip to Content

Waiting for the market correction. What should be your action plan

Stock market corrections can feel frustrating to wait for but they will come around. Focus on your plan when it does.

There are readers that regularly tells me they are waiting for the next correction to buy stocks they find its good but missed out on.

So what should be their action plan?

Some assumptions

Before we get going let’s  set some things straight here.

  1. We are talking about prospective stocks that  you would want to hold 1 year and out not fast trades
  2. You probably won’t have an idea this is a correction or a full blown bear. You could have guessed but perhaps you won’t have a 90% answer
  3. We are not talking about non-systematic risks here or risks events that affect a particular segment or individual stock

Step 1: Understand the stocks’ valuation

If you are buying for value then the most important thing is to gauge value.

Valuation takes in

  1. The business model (cyclical or recurring,  etc)
  2. Business climate
  3. Known risk, and unknown risks
  4. Forward looking cash flows
  5. Conservative cash flow estimate
  6. Liquidation value (amount that can be sold off for valuable assets)

On my site here there are many more articles that I show to gauge value.

Why is this important?  If you know the value versus the price pay,  you will have a higher margin of safety.

In a bull market stocks get over extended and  it is valuation that rationalize things.

If you have not assign a value to it,  you will do what I did.

I bought Interroller, now known as Pteris which is a darling dividend stock when the price corrected 20% from $1 to $0.80 thinking I have a bargain.

Pteris have lost its management when they retired and business competition have increased dramatically.

My valuation got messed up. Pteris is languishing at near 10 cents now.

Sometimes there is a reason why things are cheap. The floor has permanently moved.

Valuation is fluid. You do it for your existing stocks, you do it for your prospective stocks

To make things easy for yourself, this step can be done if the climb is long drawn and instead of getting all anxious, do this step first to get off that feeling.

It will also save you a lot of time cause when the market  drawdown comes you might not even have time to do this as it takes time. (I just took 2 days to look through Stamford land over the weekend and that is just one superficial look at one stock)

Step 2: Know the size you want to build up and break it into a few portions

This is one that I find that I didn’t stick to and perhaps cost me.

If it’s a correction of 10%,  you mind will play tricks on you whether to wait as there are more to come or this is as much.

Step 1 gives you an idea if this is a good enough buy point, step 2 ensures you take the psychology out of it.

Always know the size you want to build up eventually. If it’s 10% of your portfolio or 15k, divide into 4 portion

If valuation is attractive, buy using one portion.

If it goes down another 20%,  use another portion.

If it goes down another 20%, use another portion.

Instead if it goes up,  at least you are 1/4 vested. Markets move in cycles and if it’s a mild 10% correction chances are the next bear will give you some opportunity.

Waiting for the absolute bottom is difficult. Many folks were doing that in a 20% market correction in 2011.

They were so happy to be in 100% cash.

Step 3: Understand and master market psychology

Instead of swaying as part of the herd, visualize from a third party perspective how optimistic and pessimistic the crowd is.

You get a better deal when buying at extreme pessimism and not buying into extreme optimism.

Technical breadth indicators such as oversold rsi and stochastic on weekly charts will indicate a relative level of pessimistic conditions.

It’s not easy to master the market psychology part of the game. Learn how your brain works and work around it.

To a certain extent being partially invested is a way of combating against the thought of jumping in.

People have a  tendency to jump in when they are thinking they are missing out on a great opportunity.

Conclusion

These three steps need to work together. If you have step 1 without 2 and 3, you will be suck in investing your full amount.

If you do step 2 without 1, you average in at overpriced condition or a stock that have seen a fundamental shift.

If you do 3 without 1, you do a great timing on a lousy long term holding (which sometimes works out sometimes doesn’t)

How is your methodology different?

This site uses Akismet to reduce spam. Learn how your comment data is processed.

YC

Monday 15th of April 2013

Great article! Just want to comment on Point 2: for stocks that I have under a "value-play" strategy, I tend to buy into upward strength (price and volume) rather than on dips, but always having the valuations in mind. This is a signal that the market is finally recognising the value in the stock. A good example recently is Silverlake Axis.

Also, I have a loss amount (~15%) when crossed, I need to go back to reevaluate the investment thesis. I take the dip as market telling me that I might be wrong.

Kyith

Monday 15th of April 2013

Thanks for helping me with that. I think buying on a uptick is good. Long term wise it may not make much a difference

sgx stockpicker

Sunday 14th of April 2013

Hello,

I have a feeling that there will not be a sharp correction in the next six months in America. In Singapore, it will be tricky to guess but I think all the money being chased out of property will have to flow somewhere, maybe the stock market?

I have got no solid methodology other than looking at volatility measured by day-to-day changes...

Kyith

Sunday 14th of April 2013

I think there are some justifications to what you are deducting and hay we are far off the 3800 highs.

Musicwhiz

Wednesday 10th of April 2013

I think Buffett summarized it well when he said that as investors we really need to know only two things - how to think about businesses (i.e. how to value them) and how to think about market prices (i.e. psychology). That's all there is to it, but admittedly the analysis part can be tedious and tiring; it's necessary however in order to get a good feel of the business and its prospects.

Kyith

Thursday 11th of April 2013

Well you gotta do it if you wanna earn money consistently.

Hossain Shakib

Wednesday 10th of April 2013

Hi Drizzt,

Thanks for the great tips. all 3 steps are important. On step 2 - Sometimes it is difficult to gauge at which price levels there will be a trend reversal. Do you mean 1 portion in terms of dollar value or number of stocks?

Lets take Singtel for instance; If i buy 1 portion every 20% drop, then only max out at 80% loss?

Personally I would buy equal portion (no. of stocks) every 15% drop in value but be a little cautious if more than 30% loss.

Kyith

Wednesday 10th of April 2013

Hi hossain,

I think when I say buy it under the assumption that you have taken care of the valuation and assessing of individual counters.

The psychology come into play when you see even your early investment is down 50%. This is a strategy to attempt to take the psychology out of the equation.

You take that worse case scenario where it can go down 70-80%. (note I am talking about market pricr not where you own the stock)

Your plan is Ok but I feel the difference between 15% isn't a lot individual stock wise.

We are taking it that markets bounce back more the crazier it fall. A 20-30% fall over 2 years may take a long time to recover.

One refinement could be if the duration is 2 years enter another portion since average bear is that long

This site uses Akismet to reduce spam. Learn how your comment data is processed.