It may sound obvious, but markets can go up, down, or sideways. Unfortunately, many investors get worried when markets start to head south. Successful investors have a strategy for each phase of the market. When markets do star to head lower, it is important to remember not to panic. Market volatility is normal and market downturns are often followed by market upturns. We have had large falls in the market for periods of time only for the market to head back up and more than recover those short-term losses. Here are some strategies to take when trading in a market downturn.
Hold good quality companies
Good quality companies hold their value much better than poor quality companies in a market downturn. These companies may be a good buy during these periods as they can purchased at a lower price. Overvalued and high P/E stocks will be the first to be sold off during market uncertainty and panic. If the investor is holding a good quality company, they should keep these positions as over time, the stock price will recover.
Implement tight stop losses
Stop losses in a market downturn can be used to protect from the investor from substantial losses. Tight stop losses can help investors identify underperforming stocks and cut them out before a downward trend occurs. At Fairmont Equities, we tend to use a trailing stop for our Portfolio Management clients. For most types of trades, this is a combination of a 3xATR and the 10 day low.
Real estate Investment Trusts (REITs)
REITs can be used to diversify a portfolio with some property weighting. The real estate market can move separately from the share market so REITS can provide a hedge. When there is a stock market downturn, investors might look at alternative investments such as property. REITs also provide good income which is a bonus to the investor when the share market is falling. At the moment, our pick of the REITs is Goodman Group (ASX:GMG).
It is better to stay invested if the market downturn is only slight. Selling everything and then re-entering will incur fees and you may be re-entering at higher levels, which will erode profits. Getting out as a market turns lower is only worthwhile if you can time the market correctly. As downturns are followed by uptrends, the stock market often bounces back. Investors who can time the market a bit better are usually better off by holding good quality companies as part of a core portfolio and cutting out their “trading” stocks before they shed too much value.
Invest in Defensive Stocks
When the stock market starts to fall, most shares on the share market would fall as well. However defensive stocks would hold their share price better. Healthcare stocks and utility stocks would fall less as they are defensive assets so this sector performs well in recessions and market downturns. Hybrids are also a strategy go consider.
As investors fear the end of the bull market in stocks, they may look at gold stocks as an alternative investment. Gold is also considered a safe haven when there is a possibility of a market downturn.
Short the market
You can make money from a downward market by buying exchange traded funds (ETF) which short the market. Such ETFs include BEAR which tracks the ASX 200 so a fall of 1% in the Australian share market will deliver a 0.9%to 1.1% increase in the ETF. BBOZ is also an ETF that tracks the ASX 200 and is geared so if the market drops 1% then this ETF will go up 2-2.75%. However, you need to time the market well in using these. This is because ETF’s have internal fees and if you hold them for too long waiting on the market to fall, then you end up going nowhere.
Lauren Hua is a private client adviser at Fairmont Equities.
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