StockRanks | Stockrank/ Quant Portfolio - What Do You Do In A Market Crash?

2nd Jan '16 by Noodle Hat

8 comments 9646 reads

Hi all,

I am planning to implement a stock rank portfolio with some additional filters.

As i develop my approach and set out all my rules, one question keeps coming back.

In a quant based "farming" portfolio what do you do in a severe market crash?

Day to day and in normal bull/ bear markets I will have re balancing rules ( every 12 months etc) and possibly use trailing stop losses of around 20% depending on each shares historic volatility. If these are automatic or simply alerts I haven't decided yet.

However, in a large crash such as 07/08 you may see all/ alot of your stocks drop 30% even 40%? Therefore you could very possibly be dropped out of all positions and take a 20% loss on your entire portfolio, granted this is better than dropping further without a stop loss or not having any selling rules!

However if you were more buy and hold and ran a picked portfolio then I assume you would have high conviction in the individual shares and know the business well, therefore able to cope with the temporary drop down and ride it through or take an informed decision wither to keep or sell, possibly even adding more shares as they get cheaper.

My questionis, with a farming/ quant portfolio ( such as the NAPS), filled by its very nature of stocks you may never have heard of, how you respond to a market crash such as the most recent one in 08?

Any thoughts/ rules people have would be very interesting to hear.

Many thanks.

Phil

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pka

3rd Jan '16

If you woud like to remain fully invested in stocks during a market crash, you could replace your proposed rule of having a trailing stop loss of 20% with a rule that each stock's 3 month Relative Strength must be greater than, say, -20%. That way, if the market index falls by 30% in a crash and all the stocks in your portfolio also fell by 30%, their 3 month Relative Strengths would all be zero and you would not sell any of them.

PhilHofGrowYourDough

Hi Phil,

I haven't experienced a big hit since switching approaches however there have been some bumps where all of my stocks have dropped. In this situation I have sat on my hands as this has not been an issue with an individual stock but rather an issue with the whole market. I have waited for a few weeks to allow the winners to recover and I sell those that don't.

A similar thing happened recently when Pharmas/healthcare took a hit after Hilary Clinton suggested increased taxes (I think) on that sector if she was elected. As I was holding two stocks in that sector, I just sat on them and it's getting to the stage where I have to consider whether to let them go.

I don't use broker stop losses but rather I have notional stops that I monitor in a spreadsheet so I'm not automatically triggered out of positions.

Ultimately you have to find a solution that allows you to sleep at night.

Best of luck
Phil

Novice Investor

Hi frop,

This is where you find out what you know about the companies you are invested in. A market crash unrelated to economic changes that would materially affect your companies operations and profits, should not bother you.

If you've chosen companies solely from the candidates thrown up by a screener, and done no further research, then I don't know.

NI

Buffy

tradermark

Hi Phil, your question about what to do in a crash or bear market is a common challenge for any portfolio unless you are a staunch buy and hold investor. Trying to call market tops, to avoid a potential ensuing significant drop, is remarkably difficult, as is calling bottoms. William O'Neil's "How To Make Money In Stocks" has some useful guidelines on how to monitor groups of shares and indices to be aware of when a market might be topping out. Similarly, you can use a moving average system on a relevant proxy index to check the temperature of the market and make buy/sell decisions on that basis.

An alternative to getting out is to have some form of hedging strategy, like Robbie the Naked Trader's approach of buying a super short ETF when the market is falling so that he gets a return, which is a multiple of the market fall, to offset the reduction in the value of his share portfolio. This is short term insurance and needs to be handled carefully if the market starts to recover quickly.

The other really tricky one is how to respond or to protect again large sharp falls in small cap shares. A 20% stop would have been hit recently (as my 15% one was) on TTR when the price spiked down in a single day on no news. The brave would have taken this as a buying opportunity if they could have reacted immediately. However, how do you know if there is some potentially share price affecting news that insiders are aware of that has driven the price down, but it is yet to become public knowledge, which leaves you catching a falling knife instead..?

There's no easy answer to this, just a debate on the probabilities of using stops, or some form of exit rule, to prevent even bigger losses versus having mental stops (or no stops) and taking the occasional battering if you aren't in front of a screen when the unexpected happens.

Personally I prefer stops because they take the emotion out of a pressurised situation and force you to decide in advance just how high your pain tolerance is.

Cheers, Mark

mpat89

Personal view is not to use stop losses. As a result my risk to reward is still good, i.e. maximum loss 100% of each stock, maximum gain unlimited.

If I was worried about a market crash, I would use a hedging instrument, such as shorting the market or a basket of shares (i.e. low stock ranks) using CFD products. However, you should research the equity risk premium. You will see there is money to be earnt over the long term by simply being long the stock market for a very long period of time (which means even during crashes). That said, the current expectation of this return is fairly low due to indicators such as low dividends yields (although not as low in the UK as in the US).

If you want to time the market by reducing exposure during falls, you will need to be careful that you are selling into a crash and that you don't miss the rebound back up, as these would both severely impact your long term returns.

Noodle Hat

Thanks all, interesting points. As Pka says unless i want to be stopped out of the market all together then perhaps some form of relative strength/momentum to market and analyse if it is the individual stock or the market as a whole. I was always of the opinion I would hold through such crashes with the thought that they will come out the other end after all the market panic etc! Certainly will with my index funds/ "passive" part of my portfolio. As you say I don' think there is any right/ simple answer!

On reflection and further reading I think any stop loss in my rules wont be automatic and will just be an alert for me to review the stock and situation. Don't worry I'm under no illusion I could ever possibly call tops or bottoms mark! Have just order naked trader actually to add to the bookshelf as have heard so many people recommending it.

davids_h

4th Jan '16

My understanding of a quant or farming portfolio is that it attempts to remove emotion and cognitive biases from the buying process. Surely when setting up the portfolio you would also have strict rules to remove the same biases from the selling process? If you really believe in the theory of a quant portfolio, then presumably you would apply those buy and sell rules mechanically regardless of market conditions. So if for instance you bought something because of a high Stockrank, you would then presumably only sell it after a drop in Stockrank.

Incidentally, if you want a good book on buying and selling psychology, I read this one over Christmas.

The Art of Execution
http://www.amazon.co.uk/Art-Execution-investors-millions-markets/dp/085719495X/ref=tmm_pap_swatch_0?_encoding=UTF8&qid=&sr=

It makes for an interesting read.

Rgds

David

Rusty2

My view is don't invest all your funds in a portifolio, if you have £100,000 only invest £50,000 then you have funds available if there is a crash. Yes a stop loss can help but if there is a big crash would you get the -20% price? After a crash prices will recover, if you look back you will see thats the best time to invest.

The Naked Trader book should be a good read, I have bought it yet, maybe I will. I do follow his blog which lists all his investments which is interesting, he sets targets some gains are quite modest, ie FIF he bought for 100.8p, target is 120 with a 95p stop loss. But generally they are around 30% gain with a 15% stop loss, a quick look at his sells in 2015, he has about 80% success rate.

Stockrank/ Quant Portfolio - What do you do in a market crash?

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Noodle Hat

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