Lately, when the market was tanking I had a few of my friends who invest into stocks asking me how to invest when markets are falling. When would be a good time to buy?
You probably experienced situations in the past when you bought a stock and then the stock went higher, and later higher, and higher again. It was probably a great feeling and happy investing.
But when the markets or stocks go down you buy a stock and the stock immediately falls down and you end up sitting on a loss. How many times this happened to you?
It happened to me a countless times.
Although, for dividend investor, the value of the stock or entire portfolio is not as important as income it generates, it is not much comforting seeing your holdings in red, right?
There is a way how you can avoid this effect when buying stocks in declining market or at least minimize the negative impact of falling stock prices. You can achieve it by timing your entry.
You might have heard a dozen times that it is impossible to time the market, however I will teach you a method how to bottom fishing and attempt to buy a stock of your interest at the lowest possible level. And works perfectly in a falling market!
The method can save you significant amount of dollars when buying stocks and help you to get the most bang for your money.
I have been using this method for about 5 years right now and it helped me to buy my stocks for a lot less than I originally anticipated.
So let’s dive in the rules I use when buying stocks in a falling market:
· Rule #1: Don’t use all your cash at once
When you have more than $1,000 to invest, split it into smaller amounts. Never buy your desired stock using the entire amount at once. For example, if you have $3,000 available for your purchase, split it into three $1,000 purchases or two $1,500 purchases.
Do not go however, under $1,000 dollars amount to avoid high commissions and fees unless you can buy cheap or even for free.
Why you want to split the purchase amount? In falling market the stock may continue falling after your initial purchase so you want to buy next time at a lower price and average your cost.
· Rule #2: Place your purchase above the previous market high
When buying stocks in a falling market I created a strategy where I calculate my entry based on the previous day trading. The new price is higher than the previous price (previous day high) and I buy the stock only if that price is reached. If it is not reach I trace the price down with the stock.
Here is the calculation I use to determine my entry:
(( 1/2 * ( Day Price High – Day Price Low )) + Last Price ) * 1.01
I calculate the day trading range of the stock between a day low price and a day high price. The divide this intraday range in half. Add the result to the closing price and multiply everything by 1%.
That will be your purchase price.
Let’s look at Caterpillar (CAT) example:
Let’s say, today, I decide to purchase shares of Caterpillar and I have $3,000 dollars available.
Previous rule tells me not to use the entire amount, so I split it into (3) $1,000 dollars purchases. My initial purchase amount will be $1,000 dollars and I keep remaining $2,000 dollars in reserve for the next purchase.
Today CAT closed at $59.69 a share.
The intraday high was $60.42
The intraday low was $58.25
Here is the equation again:
((1/2 * (60.42 – 58.25 )) + 59.69 ) * 1.01 = 61.38
My next purchase will be 61.38
I created a spreadsheet which calculates this price for me. I just enter a symbol and amount I wish to invest and it calculates the entry price and how many shares I can buy.
You can download this spreadsheet here.
· Rule #3: Use contingency order or “one triggers other” (OTO)
Here comes the fun part. Now that we know our entry price, we can place a contingency order or one triggers the other order (OTO). Most brokers have this type of the order available in their platform.
What this does it that you place your buy order above the previous intraday high price and then trace your purchase limit order down with the stock. When the stock is falling, the order is sitting there and doesn’t execute. You trace the stock lower and lower, and your buy order executes only when the stock reverses.
What the OTO does? It is made of two orders. One order is a trigger order and when the condition is met, the buy order is triggered. Our OTO order would look like this:
TRIGGER: If CAT last price is equal or higher than 61.38 then
LIMIT BUY ORDER: buy 16 CAT at 61.38 LIMIT.
If the stock continues falling the trigger order is not hit and thus your buy order is inactive. You trace the stock down until the stock stops falling and reverses. When the stock reverses and hits the target the trigger order activates your limit buy order.
But your buy order executes only if the price stays below the trigger price. This feature protects you against buying at big gaps up. When the stock gaps up, the buy limit order will be activated, but it will not execute.
Let’s take a look at this process graphically (if you are a visual person like me, this may be helpful):
You repeat this process every day until you buy all your shares you originally planned to buy. This method is not 100% foolproof but will help you to be buying as low as possible at stock’s reversal and not at high price.
If the stock is falling, you most likely do not buy immediately and then sit on a loss. Your buy price order will be going down with the stock and you buy at reversal. The calculation above will ensure that the reversal will most likely be a meaningful one and not just a small bounce.
After 5 years of using this method it helped me buying new stocks a lot cheaper then what I originally thought or expected or what I would have bought if I bought outright when I decided to buy.
Many times I could buy more shares then what the original calculation assessed. For example, I was going to buy 16 shares of a stock which started falling and when I finally bought after tracing the stock down, I could buy 19 shares.
With dividend paying stocks, you are able to get more dividends for your money when buying more shares and that’s what matters the most in dividend investing.