What should investors do when markets are crashing??!! 📉🐻

The market always has bulls and bears. Being able to adapt to survive, endure, learn and improve with each crash is crucial.

This is a keystone post on investing. I am always learning and refining my strategy; always a work in progress. Hence, I do update this post quite frequently.

I am not a product of my circumstances. I am a product of my decisions.

Stephen R. Covey

Stocks won’t make you wealthy. Your behavior around stocks makes you wealthy. Stocks need your help. The only thing you control, your behavior, is the biggest factor in your success with stocks.

Nick Murray

Chance only favours the prepared mind.

Louis Pasteur

The one who wins is the one most prepared.

😟 😰 The market is crashing! Where is the bottom? 🔮

This is a question that we keep asking ourselves as the market crashes. Those who are vested will find their unrealised profits being diminished rapidly, into unrealised losses and keep ballooning. There will be news reporting on every twist and turn of the situation. Experts will be explaining “I told you so” and how grave the situation is and will be. It is very sentiment driven that can result in lots of emotional wild swings as markets react to every twist and turn of the situation. We can be easily affected emotionally by the news and price swings evaporating our confidence and fear creeping in. We felt confused and anxious; hoping for the situation to improve.

“The purpose of fear is to raise your awareness, not to stop your progress.”

Steve Maraboli

Am I a lousy investor after all? Am I wrong? In a down cycle, we can suffer from impostor syndrome and self-doubt in ourselves as investors. What should I do now? If we are buying low now, will the share price drop further? What is low now can become lower as the down cycle drags. We felt lost. Everyone is looking for answers. Where is the bottom? How long and deep the down cycle will be?

People prefer certainty and dislike volatility. We would seek someone (credible) that can guide and follow us through the challenging period. No one may have a clear definitive and reliable answer to how the situation will evolve, where is the bottom and what the game plan should be. Being vested, we can be more attracted to any cues of good news for the upcycle (confirmation bias).

In the midst of chaos, there is also opportunity.

Sun Zhu

Yes, as the markets tank and keep tanking and we lose confidence and conviction about our plan and stocks. Most people underestimate the downside and overestimate their risk appetite. Investors look like fools holding their investments when markets fall. The pain of a loss is far greater than the enjoyment of a gain (loss aversion). Schadenfreude will be happy with the misery of those losing. It is definitely hard being in the down cycle holding to a losing portfolio. It is difficult to be independent and a contrarian.

Don’t tune out (too long)

Together with grim news reporting, they lose interest and confidence that tune out of the market — they just shut down. It is good to tune out, get on with life and sort out our thinking and plan. It is often a question of how long we tune out. It is not easy to keep calm and soldier on to critically look at our portfolio to do the necessary — weed out the poor quality and add the high quality.

This is not a time to panic. It is a time to pause and reassess. It is a time that presents challenges and opportunities. We need to recognise the changing environment and shift our mindset to respond with intention rather than regret.

The Chinese character for the crisis is both danger and opportunity. A crisis is therefore neither good nor bad. It is just a fact of life. Opportunities exist during dangerous times. If we are unable to operate well during dangerous times, the opportunities available can be limited and less rewarding.

IMPORTANT: Have a plan and conviction, not hope

Our investing plan should focus on answering the typical 6 questions of investing:

  1. What to buy?
  2. When to buy?
  3. How much to buy?
  4. What to sell?
  5. When to sell?
  6. How much to sell?

We need a plan with a disciplined approach to ride through the down cycle. We have to be objective and decisive in planning and executing the plan. Be cautious. Do more due diligence to be objective and develop confidence in our plan. Avoid a hoping and speculative mentality. Reduce anxiety by spending less time watching share prices and news, and more time honing investing skills and researching companies.

Be fearful when others are greedy and greedy when others are fearful.

Warren Buffett

Be prepared for the worst. We are unsure when is the bottom. Apply the Stockdale Paradox.

“I lived on a day-to-day basis. … Most guys thought it was really better for everybody to be an optimist. I wasn’t naturally that way; I knew too much about the politics of Asia when I got shot down. I think there was a lot of damage done by optimists; other writers from other wars share that opinion. The problem is, some people believe what professional optimists are passing out and come unglued when their predictions don’t work out.”

Admiral James Stockdale

Learn, improve and pivot.

Knowledge will be the antidote to fear.

Keep ignoring feedback and life will keep teaching you the same lesson.

James Clear

What to buy and sell

The value of a company is derived from a few variables as shown below. We need to evaluate how the situation will affect these variables. Will revenue growth and cash flows be affected? Will it fail? Are they badly affected by debts?

Dreams and Delusions: Valuing and Pricing Young Businesses

Let us use the matrix below to evaluate and categorise our stocks:

  1. Determine the tailwinds and headwinds that are happening
  2. Evaluate each investment in our portfolio with the matrix above objectively on (a) which are the high-quality companies that will thrive better and (b) which may not do well or worse, as their survival may be at stake with the changing challenging operating environment
  3. Focus on the buy and sell lists. For the buy list, keep validating their ability to thrive in a challenging situation and their valuation. For the sell list, sell before it falls further and raises capital to add stocks from the buy list.

What, when and how much to sell

“The chief losses to investors come from the purchase of low-quality securities at times of favourable business conditions.”

Benjamin Graham

We need to ask ourselves critically:

  1. Is the sector resilient? Is the sector facing headwinds or enjoying tailwinds?
  2. Will the failure risk of the company increase? Will revenue growth, margins and cash flow be affected? Is the company doing better than the competitors?
  3. Are there better investments that we can redeploy our capital to (back to the buy list)?

What to sell is the opposite of what we buy:

  1. Revenue growth stagnates and may weaken.
  2. Gross and net profit margins will weaken and worse, it may go into net losses.
  3. It has problems generating free cash flows.
  4. It has high net debts.

Points 3 and 4 are crucial as they may affect the probability of the companies’ survival (i.e. increase failure risk). Depending on the severity of the situation, they are usually the first group that people will de-risk especially if their revenue is also affected.

During the market rally, depending on the level of irrational exuberance and greed, we may have bought these poor quality / speculative companies and worse, with leverage. Identify these companies to sell early and sell as much as possible when the share prices are higher. Should the challenging period persist longer than expected, their financial performance will worsen and their share price will keep dropping. Selling is painful. Sunk cost fallacy and loss aversion will creep in but holding on to these companies will be painful. Be objective in our analysis and evaluation and be disciplined to sell. Do not hope else we will be punished severely. Selling helps to raise capital and wait for the opportunity to switch to better-quality companies.

Buy good, buy low, keep validating and hold long

The best thing that happens to us is when a great company gets into temporary trouble. … We want to buy them when they’re on the operating table.

Warren Buffett

Share prices may fall more due to FUD and panic-selling/profit-taking (analogous to the “baby” that got thrown out together with the bathwater) than the news actually posing a material impact on their long-term potential. The market is “inefficient”. It is a great opportunity to identify and pick up gems at discounted prices (oversold) while many felt fearful, confused and disappointed that they are leaving the market.

Do not buy just because the share prices are getting cheaper. When the operating situation is challenging, it is very important to ensure that we have the right high-quality companies in our portfolio that can thrive vis-a-vis its competitors at good prices. A down cycle is a sales season for investment.

“Bad companies are destroyed by crisis, good companies survive them, great companies are improved by them”

Andy Grove

Andy Grove’s quote sums it up well.
The same can be said of investors and traders: Bad investors/traders are destroyed by crisis, good investors/traders survive, and great investors/traders are improved by them.

Companies with new cheaper and faster ways of doing things (examples: e-commerce, virtual meetings, telemedicine) will turn challenging situations into opportunities.

We need to assess how are they being affected and the extent of the impact. Here are some general parameters to look for:

  1. Ability to grow revenue
  2. Ability to maintain gross/net margin (%)
  3. Ability to generate free cash flows
  4. Has a good sizable net cash position as a buffer to withstand the down cycle
  5. Good ROE / ROIC
  6. Ability to reinvest to strengthen its moat while others are cutting back

The above should be compared to (a) its key competitors to evaluate their relative competitive position and (b) their valuation at attractive levels.

We can study how high-quality companies (such as Amazon, Microsoft, Nike, McDonald’s, and Starbucks) had been able to ride through various challenging periods and grow well consistently to become where they are now. It is great to read about their stories, and how they navigated challenges and grew.

Check out: A case study of a mega-compounder: Amazon

It is akin to finding a popular eatery that is always crowded with long queues and requires reservations even during poor economic situations.

We need to be confident and convinced in our investing plans and choices. Be more diligent to study and selecting the investing picks, following their progress to validate our thesis to gain our confidence.

Investing in individual stocks requires lots of research constantly to find these gems and the research builds conviction. Alternatively, ETFs based on key indices, sectors and/or countries can be another good choice to invest in.

As markets fall, it allows us to buy high-quality companies at a lower price — this allows a wider margin of safety, lower risks and correspondingly, higher potential returns amidst the higher uncertainty.

A good read: The Dhandho Investor by Mohnish Pabrai

When to buy and how much to buy

It is difficult to time the market low. We will not know the low at the moment but only after passing the low. This is especially difficult as we are unable to know how long the down cycle will last.

A strategy is Dollar Cost Averaging (DCA). Here, the investor divides up the total amount to be invested across periodic purchases of a target asset to reduce the impact of volatility on the overall purchase. It aims to avoid making the mistake of making one lump-sum investment that is poorly timed about asset pricing (i.e. timing the market).

We can DCA in several ways:

  1. Invest a fixed capital within every predefined period; buy $x every month
  2. Invest a fixed capital with every % or dollar drop in the market; buy $x whenever the share price drops x% or $x
  3. Invest a fixed capital whenever the price reaches a technical support level; for example: buy $x (or DCA for a period) when the weekly RSI reaches 20 which has been its lowest before it rebounds

Check out this post: A trading set-up: Bottom-fishing on a way to pick the low

Depending on how severe we think the challenging period will last, it will determine (a) how much to invest and (b) how often we DCA.

Invest with money you can afford to hold through the investments. The money invested must be able to stay invested for a long time as the down cycle takes longer to reverse. Hence, do not over-invest. Do ensure that we have sufficient funds to meet unexpected expenses.

Pace your DCA appropriately so that we do not over-invest and become anxious about having little spare cash and investing plan not showing results yet. Do not be greedy; do not leverage. It is to survive the downturn (protect the downside) than maximise the gains. It can a long ultra-marathon with an unclear finishing line.

Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections.

Peter Lynch

Portfolio management is critical. Do not over-allocate a stock or a sector; diversify.

Check out this post: The great investing myth (5): Concentration versus diversification

Learn, improve and use down cycles to buy low

Your ultimate success or failure will depend on your ability to ignore the worries of the world long enough to allow your investments to succeed.

Peter Lynch

Keep learning instead of keeping watching the market

Instead of being glued to following the breaking news and market actions, spend more time learning to improve our investing skills and diving deep into our investing ideas to continue honing our edge as share prices get lower to look for good buys.

“I insist on a lot of time being spent, almost every day, to just sit and think. That is very uncommon in American business. I read and think. So I do more reading and thinking and make less impulse decisions than most people in business. I do it because I like this kind of life.”

Warren Buffett

First, compound our learnings and over time, our returns will compound. Watching the market does not.

I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines. They go to bed every night a little wiser than they were when they got up and boy does that help, particularly when you have a long run ahead of you.

Charlie Munger

Learn from failures and be self-aware

Successful people have all failed. I’ve had a lot of failures. But I use them to learn from, as opposed to pretend they didn’t happen. If you pretend they didn’t happen, they’re going to keep repeating themselves. Admit your failures, and then learn from them.

Stanley Druckenmiller

As the market crashes, failures are painful as our portfolio goes into loss. Everyone fails before. The key is our ability to admit our failures, learn from them, and be self-aware so that we do not repeat them (especially during a bull market where we get greedy and forget the investing cardinal rules that we developed during market crashes and go euphoric again — sadly, the cycle repeats).

A great interview where Stanely spoke about being self-awareness and failure at about the 38 min mark: Stanley Druckenmiller, the #1 investor in the world – See the future differently

Napoleon’s definition of a genius is a person “who can do the average thing when everyone else around him is losing his mind.” Morgan Housel felt that managing money is the same.  To be a good long-term investor, we have to be able to manage our portfolio and navigate through various situations like the great companies we invest in. Indeed, we can learn about managing our investment portfolio from how CEOs in managing these great companies and are resilient.

“A smooth sea never made a skilled sailor.”

Franklin D. Roosevelt

Change is inevitable. Growth is optional.

John C. Maxwell

Unpredictable down cycles triggered by black swan events (Asian Financial Crisis (1997), September 11 (2001), the Sub-prime crisis in 2008 or Covid-19 (2019/2020)) will always happen.

Change is the constant. Growth is your choice.

Our ability to handle and ride over unpredictable down cycles is critical to doing well in long-term investing.

It is far easier to figure out if something is fragile than to predict the occurrence of an event that may harm it. Fragility can be measured; risk is not measurable (outside of casinos or the minds of people who call themselves “risk experts”). This provides a solution to what I’ve called the Black Swan problem — the impossibility of calculating the risks of consequential rare events and predicting their occurrence. Sensitivity to harm from volatility is tractable, more so than forecasting the event that would cause the harm. So we propose to stand our current approaches to prediction, prognostication, and risk management on their heads.

Nassim Taleb, Antifragile: Things That Gain from Disorder

The world is and will always be filled with various economic, social, political and environmental problems. Grow up and face it, it will always be. The experts know these world problems and their severity well. Some may have been anticipating and warning about the crisis for years, during which the markets may have rallied. It is difficult to time the crisis and crashes well. No one has the crystal ball.

We do not have the knowledge and expertise to make perfect sense of the world, predict well and manage to avoid down cycles unscathed. We must be prepared to handle the unexpected and leverage it to our advantage. The companies we invested in may not have a good idea of how the situation will evolve and affect them too. They adapt and make the best of the situation.

Nobody can predict interest rates, the future direction of the economy or the stock market. Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you’ve invested.

Peter Lynch

“Returns only come to those who are willing to bear that volatility when others won’t. The volatility is the point.”

Josh Brown

Accepting that volatility is a characteristic of the markets can lead to a healthy change in our mindset toward long-term investing. It is an unavoidable part of how markets work as our investments move towards greater success. Investing is largely a mental game.

In the stock market, the most important organ is the stomach. It’s not the brain.

On the way to work, the amount of bad news you could hear is almost infinite now. So the question is: Can you take that? Do you really have faith that 10 years, 20 years, 30 years from now common stocks are the place to be? If you believe in that, you should have some money in equity funds.

It’s a question of what’s your tolerance for pain. There will still be declines. It might be tomorrow. It might be a year from now. Who knows when it’s going to happen? The question is: Are you ready — do you have the stomach for this?

Most people do really well because they just hang in there.

Peter Lynch on what do you need to become a great investor?

As the market drops, the higher the uncertainty, the lower the risk, the wider the margin of safety and the higher the rewards.

It seeks to favour those who study the risks and the plausible outcomes to determine the appropriate risk rewards.

Do not waste a crash: survive, learn and improve with each crash.

Take rein: Validate and tighten our investing to prepare for the worse

“Let me tell you something you already know. The world ain’t all sunshine and rainbows. It’s a very mean and nasty place and I don’t care how tough you are it will beat you to your knees and keep you there permanently if you let it. You, me, or nobody is gonna hit as hard as life. But it ain’t about how hard ya hit. It’s about how hard you can get hit and keep moving forward. How much you can take and keep moving forward. That’s how winning is done!”

Sylvester Stallone, Rocky Balboa

Often, our planning may not cater for being wrong and big unexpected downward surprises. We may be an optimist and cannot predict what, when and the severity of these downside surprises.

Everyone has a plan until they get punched in the mouth.

Mike Tyson

Often, conviction is a function of our buying price rather than the quality of the companies we invested in and their valuation (anchor bias). We have our conviction boosted by rising share prices and profits. Conviction evaporates when stocks get crashed and losses swell. Our buying price has created an anchor bias upon us.

The market may possibly get more and more severe. We may need to keep tightening our criteria and keep the portfolio on a tighter leash. Mistakes will punish us badly. As the business condition worsens, fewer and fewer companies will meet our criteria. We need to examine the financial results and that of competitors more closely to ensure that the companies we invested in are doing better than their competitors and the market in general.

This too shall pass but we have to make doubly sure that the companies we invested in will thrive through the challenging times.

Check out this post: Managing losses: A very important skill that investors and traders must have

The seduction of pessimism

This is the title of a chapter in Morgan Housel’s book, The Psychology of Money and a very important chapter.

Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you.

Mogan Housel

For reasons I have never understood, people like to hear that the world is going to hell.

Historian Deirdre McCloskey

People tend to be pessimistic and sometimes, cynical. It is easy to see problems and many know what is ideal and perfect. Pessimists see everything as bad, follow the bad news and opinions (affirmative bias) as well as extrapolate them “linearly” to further downside and forecast an aggravated situation. It sounds smart and logical. History is full of examples of things becoming bad and remaining bad. Turnarounds are difficult and miracles are rare. Hence, pessimism is more common, infectious, and persuasive. In a challenging period such as COVID-19, to be optimistic can be viewed as naive and insensitive; oblivious to risk.

“Every group of people I ask thinks the world is more frightening, more violent, and more hopeless — in short, more dramatic — than it really is,”

Hans Rosling, Factfulness: Ten Reasons We’re Wrong About the World — and Why Things Are Better Than You Think

Optimism begins well before it is obvious. Humans make significant progress in medical breakthroughs, technological innovations, and economic growth.

History shows that human ingenuity always triumphs in the long term, even when the short term looks precarious. With each crisis, optimism usually begins with identifying the problems, developing a plan, and executing the plan. It needs leadership, vision, determination, teamwork, time, money and resources etc. Progress at work is behind the scene; working hard to find solutions will take time. Each crisis is difficult and people doubt the resolve and capability of leaders to solve the problems. It is sometimes difficult to visualize the resolution of the crisis with the plan and to gauge the probability of success. There will be lots of challenges and failures; it will not be a smooth ride. Will it work?

Pessimism does not account for how people including ourselves can innovate, re-invent, and adapt to new situations for the better. It ignores the resilience and determination of people to help improve and turn around the situation.

We have choices. Do we want to do nothing and act helplessly with the challenges on hand and let the challenges take their own course? Proactive people focus their efforts on the Circle of Influence; focusing on what can control and take action, thereby enlarging their Circle of Influence and moving towards solving the problem.

Between stimulus and response, there is a space. In that space is our power to choose our response. In our response lies our growth and our freedom.

Viktor E. Frankl

Optimism is the best bet for most people because the world tends to get better for most people most of the time. Optimism is a belief that the odds of a good outcome are in your favour over time, even when there will be setbacks along the way.

“People often call me an optimist, because I show them the enormous progress they didn’t know about. That makes me angry. I’m not an optimist. That makes me sound naive. I’m a very serious “possibilist”. That’s something I made up. It means someone who neither hopes without reason, nor fears without reason, someone who constantly resists the overdramatic worldview. As a possibilist, I see all this progress, and it fills me with conviction and hope that further progress is possible. This is not optimistic. It is having a clear and reasonable idea about how things are. It is having a worldview that is constructive and useful.”

Hans Rosling, Factfulness: Ten Reasons We’re Wrong About the World — and Why Things Are Better Than You Think

Nothing was ever built on pessimism. Be a possibilist. Be the change and take responsibility. Optimism and the power of the human mind have continually pushed humanity to new heights.

A crisis is a terrible thing to waste.

Paul Romer

Often, the present looks bad, the future looks worse and the past looks good. Years, later, the present looks worse, the future looks more worse and the past looks better. It is a case of hindsight bias. There are always opportunities,

Strong opinions, weakly (or loosely) held

It is an expression describing a framework developed by technology forecaster and Stanford University professor Paul Saffo. He described the process as:

“Allow your intuition to guide you to a conclusion, no matter how imperfect — this is the ‘strong opinion’ part. Then –and this is the ‘weakly held’ part– prove yourself wrong. Engage in creative doubt. Look for information that doesn’t fit or indicators that point in an entirely different direction. Eventually, your intuition will kick in and a new hypothesis will emerge out of the rubble, ready to be ruthlessly torn apart once again. You will be surprised by how quickly the sequence of faulty forecasts will deliver you to a useful result.”

It is a useful default perspective to adopt in the face of any issue fraught with high levels of uncertainty, whether one is venturing into a forecast or not. It is about the ability to embrace the power of definiteness and the power of openness concurrently. And when you act, you cannot be of two minds (cognitive dissonance). You have to commit and proceed boldly. But to understand the world, you have to constantly learn, adapt, and grow, which implies shifting direction.

The illiterate of the 21st century will not be those who cannot read or write, but those who cannot learn, unlearn and relearn.

Alvin Toffler

Knowledge is having the right answers. Intelligence is asking the right questions. Wisdom is knowing when to ask the right questions.

Marc Andreessen, the co-founder of Netscape and venture capital firm, Andreessen Horowitz, is often associated with the term. Being a venture capitalist, he is always looking for start-ups with great business ideas that opposed conventional wisdom. These can be very hard to execute and entrepreneurs must have strong tenacity to work their way through. However, as the world evolves, how will they react?

There are always companies with innovative products and business models trying to create a new S curve and disrupt the incumbents.

It is not about being right.

It is being open-minded and humble. Have conviction with flexibility. Be prepared to change and pivot.

The great investing myth (6): Being right

This too shall pass.

To those who have experienced Asian Financial Crisis (1997), the dot com bubble (2000/2001), September 11 (2001), and the Sub-prime crisis in 2008, it did feel bleak, doom and gloom and may not be able to feel optimistic out of the difficult situation.

The most important thing to remember during such times is that the market as a whole has a very long history of recovering from downturns. In fact, since 1928, the S&P 500 has fallen by more than 20% on 21 separate occasions. And each and every time, it eventually bounced back.

Of course, it can sometimes take months or years for the market to fully recover from a crash. Historically, it has always managed to rebound stronger than ever.

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