A 10-step market volatility plan

It leaves many with a sick feeling in the stomach.

For a month now, investors have witnessed heightened volatility in their stocks, particularly those outside the S&P/ASX20. Wild daily swings have become the new normal, for example,  it is likely this shortened trading week will result in the first positive week in four for the S&P/ASX200 and All Ords - but it doesn't feel like it right? (Update 31/12: the market actually finished down for the week. Which felt totally normal to me at least)

Fundamental investors are scratching their heads wondering why the market doesn’t see the underlying quality of their businesses. And traders are getting whipsawed in and out of positions, which at the end of the day… just makes brokers rich!

The outcome of this heightened volatility is that many investors let go of their portfolio’s virtual handlebars, choosing to close their eyes to the reality, rather than confront their current performance. A phenomenon which is common at this time of year.

I do empathise with those that are particularly stressed due to an over exposure to the market. Whether you are a seasoned fund manager or dabbler in shares, rapid moves such as this, particularly to the downside, can often raise challenges psychologically and it’s easy to just think it’s all too hard, and want to simply throw in the towel. But I urge you, do not let go of the steering wheel leading into 2023.

Notwithstanding the economic impacts of any looming global recession or rising interest rates, many of us accept that this tough period will eventually pass, just as all the others before it have. Companies who do survive and have high factor scores (that you hopefully hold) will thrive as better days return to markets.

However, if you have experienced pain and stress in the lead up to the end of this calendar year (a time which normally is one of peace and fun), then outlined below is a 10-step market volatility plan that will hopefully put you on the right side of the eventual recovery, or at the very least, be in the best position to ride out any continued volatility.

1. First, is the painful step of getting rid of any business you don't truly believe 100% in, or fail to meet your technical criteria. Even if the losses you sit on are huge, this is not a time to rely on hope of a turnaround. Hope is not a successful long-term strategy, and realised losses today can put your future earnings to work as they will be a tax benefit later.
2. Fundamental investors can use this newly acquired capital generated through selling the no hopers, to average down into those businesses in which you retain belief in their quality. Topping up into better businesses at a bargain discount is a sound strategy when compared to holding on to an inferior company. Technical investors won’t do this as a price in a downtrend is not ideal.
3. If you have extra cash outside of the previous selling in steps 1&2, then you are in an enviable position. But as technical traders will tell you, be wary of catching a falling knife. There will be (and always is) a time for an elegant entry when the current macro picture becomes clearer... just be patient. When markets are falling is not the time to look away. Rather it should sharpen our focus.
4. If you have no extra cash, but hold other assets, then this is a great opportunity for an out-of-cycle rebalance of your asset allocation. Reduce your holding in other assets that have held up well and be prepared to top up your share market allocation (as per step 3)
5. If you've no extra cash and no other assets, then following steps 1&2 above are unfortunately all you can do. Markets WILL recover and the first steps up the recovery mountain will always be the strongest. Great quality companies will find favour when sanity returns after a big correction. However, for those with cash, proceed to step 6.
6. If you buy something, acknowledge why you're putting your money into a stock. Is it a true long-term investment (fundamental reasons) or are you hoping for a momentum grab (technical reasons)? Be honest! Volatility can mean the pursuit of a short-term gain will become a long-term loss if left unchecked.
7. If you buy a stock for the long-term, then switch off and only make a further decision after the company’s next report (due for many companies in February - with updates likely in January). Future volatility aside, if you’ve seized a bargain in a great business and it's cheaper than 1 month ago, then you need to let the company’s fundamental performance play out.
8. Jumping on for a momentum gain? Then keep your stop losses tight. Further, any large short-term investment should see you take regular profits (if you get them). Twenty per cent scoops on gains might seem a bit sharp in normal circumstances, but in the current environment it's only brokerage and makes sense. It doesn't take long for prices to move the wrong way. This of course this point is  not as relevant if you’re investing based on the fundamentals and/or have a multi-year term view.
9. If you are genuinely concerned that worse could come and wish to sell everything, then I understand. Going to cash is just like taking insurance against a future larger disaster. BUT you must be prepared with a strategy to deploy those funds once again otherwise you'll miss out like many following the GFC rebound in 2009 or the COVID V-shape recovery in 2020.
10. If you found this process enlightening, then I am sorry to say but it is obvious that you haven’t had an investment plan to follow. When you ask yourself, “What do I do now?” it's probably already too late. An investing plan removes the stress of uncertain times and turns future moments like these into great opportunities. So spend some time over the holiday season to formulate one.

It is important I share that I've held stocks that I believe in through this correction for fundamental reasons, and others that I have bought for technical/momentum reasons. Recently I have built my cash holding after selling some stock (much of that for technical/momentum reasons) and now I will wait to seize opportunities when they eventuate.

Of course, I wish the market had kept rising. But it hasn't. No one knows when the bottom will be hit, or when our next all-time high will occur. But I have a plan, I respect it, and now I execute it.

I suggest you do the same with all the tools and knowledge available to you in Stockopedia over this time of summer reflection. 

Both Chris and I wish you all the best for your health and investing in 2023! .

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