How falling markets present tough questions to investors
Share prices have fallen across the board in October, and it’s a reminder of just how quickly fear spreads when stocks start tumbling. My colleague Jack wrote this week about the sense of foreboding that’s hanging in the air at the moment. There’s almost a sense of inevitability that some kind of correction is past due. Knowing how to react to that kind of prospect is difficult.
Ten years into a bull run, and faced with various signs of trouble (in various parts of the world), it’s not hard to piece together a pretty gloomy narrative. While October has been unpleasant, some of the main UK indices - certainly the small and mid-caps - have been trending down since early summer. So for some investors, this experience has been less of a suckerpunch correction and more of a protracted beating.
This week the FTSE 250 has been flirting with correction territory, with the index currently down by just over nine percent for the month. As usual, the UK indices are taking at least some of their cues from price action in the United States. That’s been translating into some sharp and unpredictable intraday moves - days that start well but end up finishing on yet another low.
Profit warnings and bad news
In recent weeks the sharpest falls on the FTSE 250 have been exacerbated by bad news and profit warnings. Among the biggest fallers have been stocks like Keller, ConvaTec, Superdry, Indivior, Inchcape and Victrex. In terms of relative price strength, they’ve all undershot the All-Share index by more than 20 percent.
There are similar war stories over on the AIM All-Share, where Fevertree Drinks - a stock that, size-wise, has more in common with the FTSE 100, has seen more than a billion pounds wiped off its value since the end of the summer. It’s down from £4.23bn in early September to £3.18bn currently.
But it isn’t necessarily all bad news. It’s fair to say that some stocks (a minority) are holding up reasonably well under the conditions. But it’s also the case that investors with at least half an eye on value have been crying out for a meaningful correction for several years. For many, what we’ve seen so far won’t be anywhere near enough. As a result, we’ve got a melting pot of emotions. There are those selling up at the prospect of mounting losses and uncertainty. There are others prepared to stay invested and sit out the turmoil. And there are others readying themselves for the chance of some bargain hunting.
Deciding which position to take is a personal choice. But it’s worth bearing in mind the human instincts that can be an influence...
Fear of loss
One of the most recognised behavioural challenges in investing is loss aversion. It’s a concept closely associated with prospect theory, which was developed by the psychologists Daniel Kahneman and Amos Tversky.
The idea behind loss aversion is that the pain of a loss is a much stronger emotion than the joy of a gain. So investors go to greater lengths to avoid losses, even though it might not make sense. More specifically, the urge to avoid losses by selling up when markets are falling - even though understandable - can end up being costly without a solid strategy for getting back in. That’s because acting on emotions to avoid losses can arguably mean missing a market rebound.
Loss aversion can also lead to being too risk-averse and forgetting that, as an asset class, stocks will always encounter periods of volatility. Even so, they still tend to outperform other assets over the long term.
This problem gets worse when you mix loss aversion with the other well known emotional tendency of constantly watching portfolio performance. When that happens you’re at risk of myopic loss aversion. The more you look, the worse it gets before, ultimately, you become paralysed by fear and make costly decisions.
Research by Schroders earlier this year came up with some pretty startling numbers when it comes to the costs of mistiming the market. Investing £1,000 in the FTSE 250 in 1987 and leaving it for 30 years would have have seen the pot grow to £24,686. But trading in and out of the market and missing out on the index’s best 30 days would have left you with just £6,878. It’s an extreme example, but the point is that time out of the market might limit the downside, but it also risks missing out on the upside.
Deciding to get out of the market in the face of mounting losses is a personal choice. But if preserving sanity means selling up then it’s worth having a strategy for getting back in again. The advice for staying in the market through highs and lows really hinges on the idea that, psychologically, it can be difficult to time the re-entry. That unintended consequence could end up end up being even more costly than just sitting tight and weathering the storm.
Either way, in times of stress it’s handy to call on a classic quote from Warren Buffett - a man not easily shaken by price swings - to try and get things into perspective:
“If you expect to be a net saver during the next 5 years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”
Photo by Brendan Church on Unsplash
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Of course the notion of behavioural investing came a lot later.
Earlier, actually. Joseph de la Vega wrote Confusion de Confusiones in 1688, 30 years before the South Sea Bubble.
People follow gurus without thinking:
“There are times in which the powerful investor is followed by many, even at the cost of losing money”
People seek confirmation from others (and, of course, often react violently when opposing views are offered):
“It is not important that the basic value of the shares be practically nothing as long as there are other people willing to close their eyes and support those contradictions”
People will trade for no obvious reason other than their own overconfidence:
“They will sell without knowing the motive; and they will buy without reason. They will find what is right and they will err for fault of their own.”
De Vega came up with four principles of investment that are as true today as they were then:
- Don’t advise anyone to buy or sell shares.
- Accept your profits and your regrets without looking back.
- Profit in the stockmarket is transitory.
- To succeed you need money and patience.
True 330 years ago, true now and, no doubt, true in another 330 years.
timarr
Hi Tradertimes82
Firstly commiserations on your losses, but I guess not many were completely unscathed (funds have gone down too).
I turned to cash, but not before the fall before many my stop losses were triggered, so still down around 7%, but now that I feel it was a mere correction, not an impending crash, I am missing some upside as the markets spring back (which of course doesn't mean a major fall wont happen, but nobody knows), as I start to carefully reinvest, with the inevitable dealing costs and stamp duty, etc.
Don't let the recent correction cause lasting damage to your frame of mind (your portfolio will fix itself if you are patient enough!). Its all learning and nothing should be catastrophic. One thing is to think about risk management as you rebuild. What is the worst thing that could happen? It's a phase and will pass. Strategy (stay in or get out for a while). Tactics e.g. stop losses. Maybe using a temporary short of the market as a counterbalance (then selling it again when the correction has finished). The fund £SUK2 shorts the FTSE100 to the power of 2 and can be used as a counterbalance to your long investments and you only need half the capital to have the same effect ( short term fix only, though). Look at the Stocko conservative stocks, maybe, while we are in these volatile times.
Finally, Its great learning. Robbie Burns, Jim Slater and many other fantastic investors (let alone us mortals) served an apprenticeship and lost money in their early days and everyone has spells when they lose from time to time. Its about making more on the roundabouts than you lose on the swings.
The most important thing is to be patient and not overreach. Think as much about minimising your potential losses as maximising your potential gains. Stocko tools help with this. Invest with risk management in mind and do whatever it takes to preserve a good mental attitude, or this will surely affect your investing and decision process.
If necessary, step back, take a break, have a rethink, then, if you chose, come back with a stronger strategy.
Cheers,
Mark.
Thank you for this advice, believe me it is much appreciated, I certainly needed to read another perspective.
Thanks again for taking the time to reply.
Thanks for this, another great reply. Yes I am strongly considering whether investing is for me. I thing I need a rest as Markj777 suggested and I take on board both your comments as I attempt to stumble forward.
Thanks again for taking the time to reply.
I've increased my position on my DAX short today by 50% due an increasingly bearish weekly Ichimoku Chart. Things that triggered it for me were the price hitting new recent lows (intraday and daily close) and also note everything is pointing south, i.e. the slow and fast moving averages, the boundaries of the cloud and the lagging line
If the FTSE 100 drops further tomorrow increase my short on that position too. Ideally I'd be looking for new lows (below 6850) and another lower close (below 6984).
Hi dfs12,
The fantasy fund league is interesting but you need to dig a little deeper when looking at the results.
Many of the top funds run by subscribers have erroneous spikes in their value due to incorrect handling of share splits.
That said if you look at the 3 year returns active fund manager shipoffrogs has very good returns.
Best of luck
Phil
Well it took a little longer than I expected but I've increased my short position on the FTSE 100 by 50% today. The way things are heading this week we are looking at the lowest weekly close in 2 years.
I'm still not short on the US markets and personally if they are going to go south I'd be much more comfortable shorting them in a couple of months time. For example to short the DOW as of today I'm looking for a weekly close below 22188 which is currently 2300+ away. So by the time I'm ready to place my short the big moves might have happened. However looking forward in February 2019 I'd be looking for a weekly close below 24148 (442 pts difference) or in March 2019 the price could close around the current level.
Anyway interesting times ahead and whilst Trump is in play there is going to be a lot of volatility so be careful out there.
Best of luck
Phil
The US charts are starting to look hairy now ...
S & P 500
Last week's price action close below the cloud and this week's price action is pushing into new 9 months lows and the lagging Chikou is wandering into the cloud. The moving averages that form the cloud are poised to cross turning the cloud Bearish. Even if the price action consolidates at this level it'll be 5 weeks before the lagging line falls out of the bottom of the cloud. Closes below 2500 don't look that far fetched over the coming weeks and that's going to take the lagging line below the cloud and if that happens for two consecutive weeks that'll be my signal to go short on the US market.
S & P 600 Small Cap
Today's lows were a 14 month record and the lagging line is sitting in the middle of a thin cloud (limited support). The cloud is about to turn bearish too.
Be careful out there!
Phil
Hi Carey,
I've come close to pulling the trigger. I'm looking for the blue lagging line to close below the cloud for two consecutive weeks.
I think the outcome of the China trade talks are going to push it one way or another but I can't decide which way it'll go at present.
Best of luck
Phil
I'm still sat on my shorts for DAX and FTSE. With everything that is going on I'm in no hurry to close them. March is looking interesting both in terms of Brexit and US/China trade negotiations. Given that Trump has had to cave on the wall legislation and that he'll face legal pressure if he tries to invoke emergency procedures I'd suggest that he'd be looking for a good result regarding the US/China talks. I think he'll want to appear tough. But aside from that the shorts hedge my portfolio at present and although the performance of my investments has been flatish, I have a good insurance policy against some very real headwinds.
Best of luck
Phil
btw my preference was that the US market held out until march time before capitulating as entering a short position at that time would mean that my other investments wouldn't have been eroded by a wider market collapse,
i.e. it's a bigger drop from Decembers SPX chikou (value appears in May in the charts as it lags) to the bottom of the Kumo (for two consecutive weeks) compared to Mar's SPX chikou to the bottom of the Kumo.
I've tried to highlight that below in Orange
With the FTSE, even after the recent rally it is still Bearish. My exit strategy is two fold. I'll exit either when ...
- Blue TenkanSen (fast MA) crosses Red KijunSen (Slow MA)
- Flourescent green stop loss is broken by price action. The stop loss is the KijunSen displaced.
The DAX weekly chart is still very bearish. Same exit rules apply
This is very much my own strategy so please do your own research. It's quite likely that I'll lose money on the shorts but that'll mean that the market has rallied and my other investments should do well. In the meantime I have an insurance policy against something very ugly.
I'm bumping this thread because I think it is one of the best threads on Stockopedia about determining when a macro event (such as Corona Virus) might be something that we can just ignore or when we might be able to determine that it is turning into something more serious that might cause us to take a different action.
We are talking here about using stats and data on the market to change the course of our thinking rather than rumor or opinion and I think that's an approach that is always worth considering.
Its not always appreciated but the process of us tipping into a recession or bear market actually happens relatively slowly and the principle in this thread is trying to work out if that really is the happening right now or not.
@PhilH I think the next days/weeks are going to interesting to see if the markets trigger your exit rules.
Hi PhilH,
Would be interested in knowing if your exit rules are now triggered in this latest Corona Virus market drop? If you are using weekly periodicity then I think using your original criteria of the lagging line going under the cloud for 2 weeks then your exit rules have not triggered. If you are using the rules in this post then I think they probably have triggered.
I would be interested in your thinking this time around.
cheers
Carey
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Hello Tradertimes82,
"Trading" isn't for most of us. Try "investing" instead. The AIM market is particularly risky with only a little wheat amongst the chaff.
Who do you trust? Only yourself. There are some good fund managers if you want funds but not that many. There are some good managers and management teams in companies, but the median will be disappointingly poor.
In respect of this UK market sell-off we were here before as recently as April! The "value" orientated stocks I hold have been hit too but my dividend expectations remain undiminished. I think the shares I avoided as "over-valued" have been hit hardest along with the fundamentally poor business models and the over indebted.
Sometimes it's about avoiding the losers rather than picking the winners. Investing with a longer-term outlook is much easier and more rewarding than trading short-term. I bought LON:(RDSB) at £14, I see no reason to sell at £25 while they pay me 10.75% on my investment cost. Chase shares that could double in 12 months, not today thank you; I have learned to be grateful for the 10.75% and the share price will bob up and down with the market.
Bonitabeach