Buying during a market crash may be the best way to make money in the stock market. But how many people actually dare to buy during a crash? During a market crash, there will be many negative news on the economy. Let me share with you my experience during a market correction. I would not classify this as a crash as its considered mild compared to a real crash.
This was during the year 2011 where there was a possibility of a huge economic crisis looming. First it started with Greece defaulting on its debt then it spread to other neighbouring countries such as Spain, Portugal, Italy, France etc. Some of these countries were the top few economies of the world and they were in trouble. Many economist predict something disastrous is going to happen. The US market dropped almost everyday with a 600-800 points drop on the Dow Jones Index on some days. I saw the biggest decline on the STI i've ever seen with a 100 points drop in a single day.
It is hard to buy any stocks when there is so much negativity. But those who did invest during these times would have made a huge profit and return on investment. It is therefore important to have a war chest(cash) on standby to take advantage during a market crash. How did these individuals manage to buy during times of trouble? I believe to have the courage to do that, we need to trick ourselves into buying and also have a clear strategy.
The trick yourself strategy
The main reason why people are not investing in times of trouble is because of fear. Fear is all in the psychology of the mind. You want to buy a stock but you may think whether this stock will drop further? The way to counter this fear of a stock dropping lower is to divide your capital into different tranche. Do not buy a falling stock at one shot with all your capital. Buy some first and buy the rest if it drops lower. But how to know at which level to buy and how much to buy?
Stocks typically drop around 50%-60% during a market crash
Typically, during a market crash, most stocks drop a maximum of around 60%. Of course this company must have strong fundamentals and a good track record of profits. A bad company can lose everything and go bankrupt during a crisis. Knowing the stock price of good companies drop a maximum of 60%, we can divide our war chest into 2 tranches to buy first at 30% drop and the second at 50-60% drop. Or we can divide our war chest into 3 tranches to buy the first at 20% drop, the second at 40% and the third at 50-60% drop. With this, we will always buy something during a market correction or crash and at least make a decent profit. It is better than trying to predict the exact low of the market and end up not buying at all which most people do. Many end up waiting for the stock price to go lower and scared that the stock price will continue falling. The psychology of this state of mind prevents one from buying stocks at a low.
Real life examples
Technical analysis can also be one way to guide us on our entry buy price. By looking at charts, we can know how much a stock typically falls during a market crash. Below shows the chart of the company called OCBC bank in Singapore. During the 2007 financial crisis, this stock fell from $9.45 to a low of $4.14. That is a 56% drop. If we had bought first at 30% drop which is $6.41 and second at 50% drop which is $4.75, the average price will be around $5.58. The stock recovered from the low of $4 plus to $7 plus in just 3 months. You would have made a profit if you dared to buy during the crash.
If we look at the year 2000 dot com bubble crisis, this stock also dropped around 56%. If we had used the same strategy, we would also have made a profit.
Let's take a look at the next company, Singpost. This is also a stable company with strong fundamentals. In the 2007 financial crisis, this stock dropped about 53%. Applying the same strategy to buy first at 30% drop and the second at 50% drop, the same profit would apply. As we can see the stock price has already went above the high of year 2007.
There are cases where the stock price of a company is cyclical in nature as seen in the company SIA(Singapore Airlines) below. This stock dropped 60% during the 2007 financial crisis. For cyclical stocks, we can still deploy the same strategy of buying in 2 or 3 different tranches but it will be futile to hold the stock throughout unless you invest solely for the dividends only. The stock price of these cyclical companies fluctuate up and down a lot and goes in a sideways fashion. Most of the time its better to sell it off for some profits before the next crash comes.
There are many other factors to consider when buying a stock and each stock may behave differently. This blog post would not be able to cover all strategies. By allocating our assets efficiently and minimizing our risks by diversifying into a few other stocks, we can all make some money from the stock market. When the market is all good and prices are climbing, always remember to stash away some cash (war chest) to invest during a crash. As the market goes higher, i actually lessen my exposure to the market and keep more cash. There will always be some form of correction which will allow us to buy stocks at much cheaper prices. I have prepared myself to 'trick my mind' into buying during a market crash. I know at what levels to buy and which stocks to buy when the time comes. Being prepared may be an edge to win this battle. Are you prepared for it?
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1. Buying the company on the streets (Part 1) - Discovery stage
2. How to pick stocks (Part 1) - Economic Moats
3. Understanding financial statements (Part 1) - The income statement