Trading, Value Investing

Learning Points from the Current Crisis

I haven’t been looking at the stock market for probably close to a year, but recently got involved again due to the worsening crisis (well, at least what’s reflected in the stock prices).

Just wanted to capture a couple of learning points from the current crisis:

  • Stocks of asset management firms and hedge funds will get hammered more because of two reasons (see FIG and BX for examples):
    1. Customer redemptions due to the panic, forces hedge funds and mutual funds to sell at low prices into the market panic and prevents them from taking advantage of the good buying opportunities available. The exception are funds that clearly holds lots of cash that are not “callable” in preparation of buying in true market crashes (e.g. Berkshire Hathaway’s $40bn cash warchest).
    2. Market conditions affect firms that the hedge funds / mutual funds have invested in, either lowering valuations or requiring additional funds and effort to ensure that those firms survive through the crisis.
  • Low liquidity stocks (e.g. Preferred stock) will get hammered more because
    1. There are fewer shares to go around, hence fewer buyers to compete for shares that are being sold, hence the bid is lower. Buyers take advantage of that to offer even lower bids. Buyers also offer lower bids to compensate for the lack of liquidity.
    2. In panic selling, sellers are forced to sell at the low bids, especially when margin calls are hit.
  • Because of the reasons above, good low liquidity stocks may be bought at terrific bargains during a crash. However, do not buy into low liquidity stock until minimally the following three conditions are met:
    1. A crash has occured (refer to Cramer’s definition in my previous post, e.g. headlines of markets crashing worldwide, people ruined, blood on the streets, etc.).
      If you buy low liquidity stocks before the crash, you will find that you will be holding them all the way down. This is because the crash happens very quickly (e.g. in 2 days), the drop in the bid is huge and sudden, and buyers only bid at rock-bottom prices.
    2. You are prepared to never be able to sell the stocks until the market has recovered (which may be years later). A recovery in the general market may not cause the low liquidity stocks to recover.
    3. You do not take on ANY debt if a large portion of your portfolio is in low-liquidity stock. The huge gapping drops in the price will cause margin calls extremely easily.
      As an example, I bought NCT-PB at $9, with a buffer of $6 before hitting a margin call, and the stock tanked in 2 days to $3.
  • Stock market crashes happens quickly, within 1-2 days to a week. Spread out any buying to over at least a 2-week period. Capital is the MOST important thing to have in a crisis. Use it sparingly. Do not exhaust it within a week and get slaughtered in the next.
  • I cannot over-emphasize that Capital is the MOST important thing. Cash is KING.
  • Do not be overly tempted by 52-week lows. It can ALWAYS go lower. Wait for the true mega plunge before committing the bulk of your capital.
  • So far, this crisis have stocks trading pretty range-bound (at low prices of course), with some occasional small dips and a large plunge so far (plunged on 9-10 Oct). Some trading rules for such a market:
    1. If a company plunges due to a “structural issue inherent to that company” (e.g. AIG, WB, MER), you can put the bulk of your capital in due to the over-reaction. Be prepared to sell intra-day (i.e. on the same day) or the day after.
    2. If the overall market drops and you want to take advantage to buy positions in certain companies, spend at the most 20% of your capital. Similarly, sell off immediately when it has recovered to the average of its trading range. You should be holding all cash most of the time.
    3. If it drops further after you’ve put in the 20%, hold and wait for a few days. If the mega plunge happens, go in with the rest of your capital. If nothing happens, you may buy in a little more (max another 10% of your total capital) and hold.
  • Do not do dollar-cost-averaging all the way down. That should only be done in good times. Be prepared to wait a few days (min. 3 or more) to determine if its a mega plunge before committing capital.
  • PUT IN THE BULK OF YOUR CAPITAL ONLY IN A MEGA PLUNGE! There is nothing worse than running out of capital at the rock bottom of a plunge.
  • Look out for “special opportunities”, e.g. 10-for-1 reverse stock split with unaware speculators selling their stock at low prices thinking that there was a jump.
  • With high market volatility, dividends are not important. Do not buy a stock to capture dividends. Capital gains/losses occur much more easily and will invalidate any dividends gained anyway.
  • Cramer is right – do not fight the cycle. Secular growth stocks like Walgreen (WAG) survived much better than others. Those may be safe harbours when the possibility of a market crisis is looming, and yet you don’t want to pull all out from the market.

I’ll update this post as I learn more🙂


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