Today the market ended down again. The S&P 500 lost 1% today and confirmed that we are still in correction. How a small investor shall trade or invest in this market? On the internet you may find a lot of information how to deal with this market. Some say sell or reduce your positions, others buy more, others stay aside and so on. Which way to go?
It depends on your investment in your portfolio and your strategy. All above mentioned strategies are basically correct but they do not apply for every strategy. It is hard to pick the right one, mainly when those advisers do not tell you which strategy they are referring to.
For myself it was confusing a lot to understand what approach to chose. I was afraid of buy & hold strategy when seeing stocks falling down and I was supposed to hold them. And in my first investment child-steps I saw a lot of loses. And timing the market, which I did wrong obviously, didn’t work for me as well.
So how do you invest in a weak market? Or volatile market like the one we are going through these days? It depends on your strategy you select and stocks you wish to invest in. I will try to review those investments and what approach works for me:
If you invest in mutual funds like I do in my ROTH account it almost doesn’t matter what you do during bull or bear market. You can invest all time and select buy & hold strategy. I like falling market, because I can be buying cheaper. I use mutual funds to accumulate money into such level that I can buy stock in larger lots to eliminate cost on purchasing stocks or ETFs. But if you use funds as your major or only investment vehicle then continue buying.
When to sell mutual funds? There are a few reasons when you want to sell funds. Definitely I would wait for bull market unless there is some serious reason or upcoming disaster which forces you to sell. One reason would be that the fund no longer meets your investment criteria. For example I am investing into dividend paying mutual funds. If the fund stops paying dividends it will be a reason to sell. Another reason can be if the fund changes strategy, for example you used the fund as a tool to invest into small caps but later the fund changes its policy and allows investing into large caps. You would want to reduce position to meet you allocation (or even sell the fund and choose another one).
Stocks & ETFs
This is a whole different story. And the most confusing. Buy and hold? Or time the market? And what about leveraging? Will margin calls catch you with pants down? You need to know in what stocks you want to invest. Are the small caps, large caps? How volatile are they? Here is my approach:
Sometime ago I chose to invest majority of my money into dividend paying stocks. Some smaller portion of the account can be invested into small caps and volatile, speculative stocks, options and ETFs. I also chose to use leveraging by buying on margin. I have seen many opponents against leveraging your portfolio, but it works for me so far and later I will try to explain why.
Lets take a look at dividend paying stocks. When you ask yourself what companies pay the dividend, you will see big, international large caps. These companies are so big that they tend to react to market volatility with almost no impact (even though today we can see some large swings too, but these are our friends actually). A great example I would like to use is Johnson & Johnson company. Recently the stock went through many recalls. People on investment forums were predicting the end of the company. And the stock was falling. Partially because of the problems with production, partially because of the market sentiment. However, the company didn’t touch its dividend. A great signal, that all the problems didn’t affect company’s ability to make money. Small company wouldn’t afford anything like this. Thus there was no reason for such panic and thus Mr. Market was our friend and offered us a great price of the stock.
So when the market is weak and falling I wait, save money in my account to make them ready for action. I do not sell the company cuts its dividend. When the price drops down and the market recovers I act and buy. (I call this timing the market).
Even if you are not much into dividend paying stocks and you are just large caps guy, you won’t make it wrong if you take similar approach.
What about small caps? Here, I do the right opposite. When the market shows correction and those small caps or speculative stocks turn down and meet my criteria for selling I sell. An example in my portfolio could be Actuant Corp. Recently, when the market turned down I had two reasons to sell: I wanted to release money for my future investment and second the stock met my sell criteria. It is not a stock which fits my dividend investment criteria and I consider it as speculative, so I sold. When the market gets into rally I will buy speculative stocks which meet my screening criteria (as well as if my allocation and portfolio building strategy allows). I still may buy ATU back when this sell off ends, which no one knows when that happens.
How this works with leveraging?
I selected to use leveraging of my investments. I believe that if managed carefully and not recklessly you may achieve a lot better results when you expose yourself to more stocks than when you invest 100% only. Buying on margin allows me to invest 200%. I found a lot of people being against this strategy as dangerous. But how dangerous it is compared to your mortgage? When buying a house, you come up with 20% down payment and borrow the rest for 30 years. I think there is nothing wrong with stocks when you put down 50% and borrow another 50% from the broker and pay the loan for next 30 years or so.
Of course, you should select equities which are not such volatile such as dividend paying stocks or index funds or ETFs. Over time the market will help you to pay the margin off and as you age, you start de-leveraging your account. But what to do if the market falls down? A common sense would advice to buy more shares, right? If you are fully invested, you should be reducing your positions or as in my case wait and stop adding to your positions. Since I started leveraging recently, rebalancing by selling makes no sense for me otherwise it will be very costly for me. So I took “do-nothing” approach. i am just waiting, sitting aside, and saving money by contributing (paying down my margin loan) into my account. That makes my buying power growing and I do not get caught by a margin call from my broker.
And of course, do not try to leverage your account with small caps! That can kill you.
Oh such volatility
Times changed. Today, investors have access to information from around the world within one mouse click and a few seconds. Markets are volatile like never before. For a long time I had a great issue with this volatility. How to deal with it? How to trade it? i couldn’t find an answer which would work for me. This volatility is the reason why so many investors claim that timing the market doesn’t work. Of course you cannot catch the bottom or top of the trend. No one can do that. But you can do swing trading changing your side based on the trend and be long when the stock grows or be short when it falls. But how to do it and what indicators to select?
Well, if investing into dividend paying behemoths it almost doesn’t matter. You just wait for next dip or fall and add to your positions. But if buying other than dividend stocks the approach should be a bit different.
You can select whatever indicator or oscillator you want (I like StochasticRSI), but to avoid getting in-and-out it is important to use at least two-time-frame perspective and use weekly time frame rather than daily. I used to look on daily charts, but the volatility was so heartbreaking that I had to look at different point of view and adjust my strategy to weekly charts and ignore daily up-downs. Look at an example GT Solar International. A daily chart shows volatile stock. Well if you are a day trader or you have time and account large enough for more frequent trading this chart is your friend. I cannot afford it. I need to hold the stock in longer period of time – at least a couple of months. This chart would kick me out of the stock very often and fees would wipe out my portfolio quickly.
But take a look at the same chart in weekly period. See the difference? It is a smooth uptrend. Nothing huge, but uptrend which can provide a peace of mind and forget all the daily craziness on the Wall Street floor. So if you use automated trading to eliminate emotions just adjust your oscillator to weekly trend and continue trading as usually.
This morning I have read an article at Yahoo! that the bull rally is dead. I cannot say whether it really is or not, but what I can say is that I welcome it. I can buy cheaper stocks I am interested in. So if it is dead, it won’t be dead forever. It has never been dead for ever. So lets wait, save money and be ready for new bull waiting round the corner.