The coronavirus has finally taken its toll. Honestly, it’s not really a surprise, given the economic complications caused by the rapid spread. However, what is surprising is the speed of the pullback in the stock market.
In just 10 days, the S&P 500 went from a 52-week high to a 52-week low. That’s never happened before. It sent the VIX to roughly $50, as investors ran for cover.
It’s not the first selloff we’ve had to experience and it won’t be the last.
Veteran investors have learned to endure these types of declines — even ones as rare as this. In order to take advantage of the long-term compounding we experience in the stock market, we have to take our punches too. There’s a reason those returns are so good over a long period of time, and it’s because of volatility like this.
But what can we do to feel better when these types of declines come our way?
How I Handle a Pullback in the Stock Market
The simplest way to invest in the market is scheduled contributions into a fund or ETF. There’s little to no thinking, it’s hands-off, and over time, it returns plenty of money (we’ll get to the stats in a minute). But a pullback in the stock market can still be a gut-wrenching event, especially for investors that own individual stocks.
First things first: learn to keep some cash handy. Whether it’s 7% to 10%, 15% or maybe more, always have some dry powder ready to deploy. That way if the market sinks 10% in a few days, just like now, we can grab some fire sales.
My second point ties in with the first one, which is to raise cash on the way up.
Some investors don’t like to sell; that’s fine. Others like to do so selectively and conservatively, as they’re long-term holders; that’s fine too. Some holdings I trade around constantly. Others I hold and only adjust every few years.
Note: be careful not to cut your winners after every rally in hopes of buying it back later for cheaper. That doesn’t always work out and over-managing can cost you big down the road!
Case in point, I didn’t sell Apple on every 10% move higher in 2019. But when it went from sub-$150 in January 2019 to $330 in January 2020 (+120%), paring some down north of $300 was a good idea, (although it was tough to stomach at first, as Apple kept rising).
But when the third — and very simple — part of my pullback strategy panned out, I felt great. That third part?…
Fingers Crossed for Lower
A pullback in the stock market sucks. There’s no other way to put it. But we can put a positive spin on it. I do so by setting low price orders on my favorite holdings. Say, buy back some of that Apple for $275 after we sold three-quarters of it at $300-plus. Buy back some more at $260.
Hey, give me some Roku at $110. Shopify at $450. Trade Desk and Nvidia at $250. I want some Alphabet at $1,300 too. Gimme some QQQ at $200. Citigroup at $62.50.
Your picks, your call. But it’s really that simple guys.
I still don’t love pullbacks. But rather than panic during them, I’ve found a way to embrace them that works for me. You can do this too, by setting limit orders on a good-til-cancelled (GTC) basis.
Buy 25 Trade Desk at limit $200 GTC
Buy 25 Trade Desk at limit $150 GTC
Maybe you don’t get the $150 fill. Maybe you do. But when you’ve kept some cash on the sidelines and trimmed some positions on the way up, you’ll find this strategy can pay off nicely.
Once you start doing this during pullbacks you’ll find yourself actually hoping for a bit larger of a decline to get more of your lower orders filled. Although I must note, this works much better when you have a longer time horizon and you actually want to own the stocks. In other words, this is for investors, not for traders.
They say the stock market is the one business where people panic when the items go on sale. Well, this is a way to reverse that mentality and take advantage of the dips. So long as the companies are of sound financial shape, here’s why you’ll want to consider it:
Statistically Speaking
Statistically speaking, the stock market is built to be a winner. Well, maybe it’s not “built” to be, but that’s what it is.
Not only does the market win more often than it loses (up 82.8% of the time going back to 1950 when including dividends), but the up-years outperform the down-years, ~17% vs. -12%, respectively.
Imagine there’s a table at the casino where you place your chips on green or red. Green has an ~80% chance of winning, while red has a 20% chance of occurring. If it’s green, you win 19% of your bet. If it’s red, you lose 12% of your bet.
What color are you putting your chips on on a consistent basis? I would guess green.
So next time it feels like the end of the world, realize that it’s likely not. And if it is, money’s not going to make a difference anyway. So invest with a level head by knowing the stats, knowing the numbers and keeping your emotions in check.
The Bottom Line
If you have some cash on the sidelines, it’s not too late to take advantage of latest pullback in the stock market. But even if it is too late, have no fear — there will be plenty more down the road.
Just remember this: Keep some cash on the sidelines. If you are comfortable doing so, take some profits on the way up when it’s prudent. When the market starts to look extended and toppy, set your GTC buy prices and wait. If they get hit, great, we got a better price for a great business. In the event they are not filled, that’s fine too, because we’re still long and can enjoy more gains. Plus it will leave that extra cash ready for a new opportunity.
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