There are plenty of investment moves you can make during a stock market crash, but this is not the obvious one.
2016 started as a bumpy year in the investment world. Shanghai stock index crashed more than 7% just 30 minutes after the market opened on Jan 7 and was forced to close due to “circuit breaker”.
This, as ridiculous as it sounds (and populated by global media), caused the global stock market meltdown for the 1st week of the year. There was nowhere to escape. In a single week,
- Emerging stock markets crashed 6.9%
- Asia stock markets crashed 6.8%
- Even developed markets crashed 5.2%
Many panic readers ask my forecast of the market. But what can I say? The truth is, I can’t even predict which clothe my wife wants to wear today (can you?), let alone for me to forecast the market.
But here is the thing, what just happened prove again that buy and hold strategy does not work (if you disagree, you can comment below). We human beings like to seek for certainty in life, but certainty is perception, and predictability is just fantasy.
Although I may not know how much return the stock markets can give you this year, I know exactly what to do now. So hear me out here…
Let’s first talk about driving
Before we dive in, let’s consider this question first: “Do you only drive your car out when you are certain that all the traffic lights along the way are going to be green?”
An obvious answer is “No”. You know no matter how experienced you are and how familiar you are with the route, there is no way to know how many red lights you will encounter.
But this will not deter you from driving right? Because you know if the green light turns amber you slow down and if it turns red you stop. Isn’t that simple and logical?
The interesting thing is that when it comes to investing, people always try to predict the exact time when certain lights will turn green, isn’t it?
Investors who drive looking at rear view mirror
Can you imagine what would happen if you only look at rear view mirror when you are driving? Is there a way to predict if the next light is green based on the patterns of traffic lights you just passed by? Does the pattern “green, red, green, red…” indicate the next light green?
This may sound foolish, but how many investors have done this? How many growth forecasts, investment outlooks you hear lately are based on past data?
In the Roulette game in Casino, you always see the “statistics” of the past betting results. Those results have absolutely no effect on the next bet, yet people can always seemingly find some patterns to justify their next bets.
The same goes in the investment forecasts. Most of them are just illusions of control.
At the same time, there are another group of people who are always waiting for all lights to turn green. It is like waiting for all the stars to align perfectly before your next move. Well, that may explain why some people never invest.
Investing through Hypnosis
Let’s go back to driving. When you are driving, do you think much about how to change gear, how to brake, how to check the mirrors? Have you wondered why you can drive, listening to music, talk via the earpiece (some people can even text) at the same time?
This is because, after enough practice, we are in a state of highway hypnosis and can respond to external events in an expected and correct manner, with no recollection of having consciously done so.
When we are in driving school, we are trained to handle different dangerous situations. Do you agree that we won’t have time to think and analyse the real danger if it arises? We just act instinctively.
My investment philosophy is the same, we have to determined what to do beforehand. When the investment situation changes, like in a stock market crash, we just have to do what we are supposed to do and move without much thinking.
Most investors know what they are supposed to do, they just cannot overcome their emotional barrier.
Global stock market crash is a new norm
In August last year. A black Monday wiped out 3 years of investment gains for Singapore stock investors. At that time, I wrote a post and explained 3 actions investors can take in a stock market crash.
Fast forward 4 months, we had another crash which knocked down the market even lower than the previous level. My colleague jokingly said that our quarterly investment meeting becomes a market crash indicator.
Time to buy more when stock prices are cheap?
I used to be a big fan of Warren Buffett’s idea of value investing, i.e. “sell when others are greedy, buy when others are fearful”. But over the years, I realise that this is a strategy appears good in theory but rarely works in real life. I find this buying “undervalued” assets and hold for prolonged period makes little sense in today’s market.
If you look at the chart below, you will find out that even Warren Buffett’s legendary investment return was developed in his earlier years of investing, his 40 over years of stock picking skills seemingly lost the magic after the year 2000.
Buying when the market falling is like catching a falling knife. Sometimes you got lucky and the market rebounded after you buy. But most of the time you will end up hurting yourself more. A good example is oil price.
The oil price fell more than 70% in less than 2 years. When it hit $80, you hear people talking about buying, when it hit $50, it became a “screaming buy”. And guess what, it hit $30 now and I hardly hear any buy call anymore.
No matter what “real value” a stock potentially is, the irrationality of the investment market can exist for very very long.
People like herding so investment markets move with momentum
If you can understand why a $1.5 Billion hedge fund has decided to return money to investors, you will appreciate that the way investing is done today has changed dramatically. With all the gigantic index funds and lightning fast algorithm trading, stocks markets are primarily driven by a herding behaviour of all the participants in the market.
With this type of characteristics, I firmly believe a simple momentum strategy will work the wonder. If you met me for my investment advice, you know I divide stocks in the world into 3 major markets:
- US markets
- European markets
- Emerging markets
At the current price level, many “experts” will tell you now it is a golden opportunity to accumulate blue-chip stocks and hold for long-term, but I find there is no opportunity in any of these markets now.
Rather than “average down” and hoping the market will recover one day, I find myself better off to get out of this mess and put my money into other opportunities.
Don’t confuse this with panic selling or taking an easy way out. Because we have the tendency of loss aversion, emotionally, selling in a downward market is a more challenging and painful decision to make than buying.
But that is how we can survive in the long run when the stock market crash is a norm nowadays.
What is your opinion on this? I would love to hear from you, leave your comment below and let’s discuss.
Hi, Ivan, you mentioned that Warren Buffet’s 40 years of stock picking skills lost its magic, and you have given an example regarding oil prices. Do you think this “stock picking skills that lost its magic” applies to all industries? If so what would be the alternative investing strategy?
Due to the technology disruption, the market is far more efficient than 40 years old. There is little edge to invest through stock picking in today’s context. But because the market is so interrelated and moves in tandem, I believe you can make money through momentum investing with rigorous risk management system.
If Warren Buffett’s investment strategy is outdated, then is there any new investment strategy that works in the modern days?
Hi, Kit Kat
It is not that Warren Buffett’s strategy is outdated. It is more like he is one of the very few who successfully used this strategy to make money, but majority of us do not have the capability and luck to do so.