What to do when the markets are crashing.
A few weeks ago, we looked at the concept of tail risk, as exemplified by the outbreak of the Coronavirus. It seems the worst is not over, and financial markets have taken quite a beating in the last few days. Where do we go from here? Nobody knows and not the question we need to answer. Can we make money? Now that is a much more interesting proposition.
Crashes are all about human behaviour. There is always a trigger, but never is there a reason as to why things should move to where they do. Truth is, whenever something happens that we are not expecting, we look for reasons to explain the utter insanity. How could global equities lose 15% in a week? Makes no sense, when put into context of how many die of the flu each year. However, any logic or rationalisation go out the window, when you see your hard-earned profits melt away, and you stare at a sea of red in your portfolio valuations.
The thing about crashes is that the minute you realise you are in one, there is nothing you can do about it. You don’t want to sell when things are already down 15%, as things will surely go up again just as fast as they went down when the worst is over. On the other hand, trying to call a bottom is the same as the proverbial catching a falling knife. Yesterday’s great entry price is today’s disaster of a trade. But buy we must and that has to do with mathematics. If the markets fall from 100 to 50, we lose 50%, if we buy at 50, and the markets go back to 100, we make 100%.
The best way to avoid calling it wrong, is to give yourself plenty of chances to get it right. In other words, you buy in stages. If you have 100 to invest, you start with 25 and pick your level. If the market goes up, you are happy because you have made some money. If the market goes down, you still have 75 to buy at better levels. Ultimately, the bet is that the markets will rebound, and they have done so for more than 100 years. So as long as you can keep buying, there really is very little to worry about when it comes to crashes.