If you are following the stock market, then you are probably aware that NASDAQ is now officially in “correction” while both S&P500 and DOW Industrial Average is down ~8% from its peak.
When professionals say that the stock market is in correction, that basically means that the market has gone down ~10% from its peak. Normally, there is no need to worry at this point. The stock market always rises and fall. However, it is not a bad idea to be on alert especially when the prices went down too fast and if the selling is accompanied by high volume like what we are seeing right now.
What to do?
What to do next depends on your stock trading strategy. Below, I will present some common trading strategies and I will share my opinion on what should be done.
What is Swing Trading?
Swing trading is when you buy, hold and sell your stock within a short time frame. Swing traders typically hold their position for about 2 to 6 weeks or even more but surely not more than 4 months or longer.
A swing trader prioritizes the technical aspect of a stock over its fundamentals. Swing traders either trade individual stock of a company or they trade ETFs for added safety.
In today’s market condition, my priority would be saving my capital. I would prefer taking small losses now instead of staying in the market hoping that the market will bounce back soon but if it doesn’t come then I will have to take bigger losses. In addition to, as a swing trader, my sell signals would have been triggered already because of the behavior of the market thus effectively removing me from the market.
I will also be careful not to bottom fish or trying to guess where the bottom is. Bottom fishing is a dangerous strategy because it is impossible to know where or when the bottom will be. It is highly likely that the market will stage a rebound but it will fail a couple of days later. It is important as a swing trader to not be greedy or impatient. Let the market bottom, wait for a bounce, then trade if the bounce is confirmed.
The best thing a swing trader could do during this time is to build his/her watchlist. A swing trader should find fundamentally healthy companies and study their charts to find out breakout points (resistance levels). A swing trader should always be alert when to get back to the market. If he/she starts to see the price action of the stocks in his/her list starts to break out (price closes above the resistance level on above-average volume) and the overall health of the market is getting better, then that is his/her queue to get back in the market.
Buy and Hold Trading (individual stock):
What is Buy and Hold Individual Stock Trading?
Another trading strategy is “buy and hold”. A quick explanation of this strategy is a trader picks and buys a stock that he/she believes will increase in stock price in the future and hold it over a long period.
I am personally skeptical of this strategy because stock’s leadership rotate. In other words, there will be a period where a stock will skyrocket because economic conditions are favorable to the industry that the stock belongs to. On its flip side, there will be a period where a stock’s performance will flatline or worse goes down because economic conditions are against the industry.
In order for this strategy to work, a trader should have a great deal of discipline in his/her strategy or really confident that his/her stock will go up over a period.
Warren Buffet uses this strategy and is successful in doing it but he has a team of professionals who can thoroughly study a company, has influence over the company that he is invested in because his stake in the company is big enough to warrant him, and is wealthy enough to be patient for the stock to rise no matter how slow it is or secured enough not to panic when the health of stock deteriorate over extended period of time.
In contrast, retail investors like us don’t have the privileges Warren Buffet has. We are more susceptible to emotionally-driven decisions because, like it or not, we are more emotionally attached to our money and would hate to see it decline.
As an individual stock buy and hold trader, I will still have an exit strategy especially when the health of overall market deteriorates.
The reason being is three out of four stocks will go down with the market as its overall market health deteriorates. In addition to, stocks tend to rise slowly but it can easily give up its gain really quickly. That means it is highly possible that a stock that I am holding during a bull market will on average rise over a couple of months or years, but during a market downturn, that paper profit is likely to disappear. The worst thing that can happen is I let the stock sit there, loss all the profit that it accumulated then it turns negative. When this happens, then it only a matter of time before my hope turns into fear which will result to me exiting my position. Hopefully, when that happens, the loss is not too big.
Buy and Hold Trading (index fund):
What is Buy and Hold Index Fund Trading?
Index trading is when you buy an ETF that mimics the performance of Dow Jones Industrial or S&P500. This trading strategy is probably the safest and the most reliable investing strategy that I have mentioned today.
For starters, if you are planning to invest your money on an index fund for more than 10 years, then you can expect an average annual return of 7-10%.
Second, index funds as stated earlier mimics the Dow Jones Industrial and S&P 500. That means if you buy a Dow Jones Index Funds then that means you own stocks of 30 large cap companies since Dow Jones Industrial Average follows the performance of 30 of the biggest and most stable companies. Likewise. since S&P 500 tracks 500 large companies, then owning an S&P index funds is like owning 500 large cap companies. The great news about this is the volatility of index funds will not give you a heart attack or will make you decide irrationally.
As mentioned earlier, buy and hold strategy on an index fund is much safer because you can expect an annual average return of ~7-10%. With this knowledge in mind, then you do not need to worry about exiting your position even if the stock market goes down to ~20%
Since you know that the average annual return of the market is 7%, then if this year’s return is -20% then subsequent years will give you a strong positive return so it will average out to 7-10% after 10 years! This strategy then suggests that dips on the market mean a true buying opportunity since the price is on a bargain unlike. You cannot do that when you only have a position on a single stock because you do not have an idea if a strong dip in a stock price would follow a strong rebound or it is a tell-tale sign of an impending doom.
As a buy and hold index fund trader, my course of action during this period of time is to continue my monthly contribution since that translates to buying more shares for a bargain price. As a matter of fact, if I have an extra money then I will buy more shares on top of my regular monthly contribution.
No need to panic… if you have a strong grasp of your strategy and you are a disciplined, rational-driven trader!
As presented above, what you should do when the market crashes depends on what trading strategy you use.
As a swing trader, your priority is to save your capital for another battle. In addition to your sell signal should have kicked you out of the market with small losses.
As an individual stock buy and hold trader, what you will do next in this situation greatly depends on your confidence to your chosen stock and discipline to stick with your strategy. You should be prepared to see your gains accumulated over a long period of months get wiped out in a week or so. Do not bail out a little too late!
As an index fund buy and hold trader, rejoice! This is a bargain season for you. Consider adding to your position during this time since Mr. Market will for sure recover. Remember that even if we know Mr. Market will recover after a decline to catch up to its 7% average annual return, we still need to avoid putting a huge one-time-big-time-lump sum because we still don’t know how long or how deep Mr. Market will go. It would be wise to divide your “extra capital” and invest it on a regular basis. It could be weekly, monthly or quarterly.
I am no professional and I am just sharing to you what would I do in times of decline in the stock market based on my experience and my research. I have been trading the stock market for about 7 years now and I have experienced many things already.
I am not recommending you to buy a particular stock or index. I’m just sharing what to expect if you do.
Always practice due diligence when trading stock market since it is very risky and it might wipe out your bank account if you dive into this business without knowing how to swim it.
Godbless on you stock trading journey!