A successful self trader – Rule # 28
Back in 2002, i asked a savvy investor the secret of his success. His answer was enlightening. Keep a crash shopping list ready and be liquid enough to capitalize on the crash. In retrospect, this is so true. We typically find investors who are fully invested at the top and hence are not able to make the best of a crash in the market. That is where you lose out. Keep a shopping list ready and be liquid in a crash.
The best bargains are always available in a crash…
Capitalizing on a crash is easier said than done. There are three challenges here. You must have the stomach to buy in a market where everyone is bleeding. Secondly, you must possess the liquidity to buy stocks in a crash, which rarely happens. And lastly, you must have the wisdom to distinguish between a buying opportunity and a bear market. Don’t be a bear market sucker.
Back in May 2004, the NDA government had fallen and a Congress government supported by the Left parties looked the likely option. Fearing that reforms would go for a toss, markets (especially PSU stocks) lost close to half their value in 3 days. The truth was that the reforms process was, by then, irreversible. The markets bounced back and the crash shoppers made a killing.
As the legendary investor, George Soros, put it “The worse a situation becomes and the less it takes to turn it around, the bigger the upside” Investors who bought US stocks in 1987 or 2009, Indian investors who bought in 2004 or 2006 or 2009 would be sitting on a fortune. But it is not that simple in reality. Creating a shopping list in a crash requires guts, panache and conviction.
How to create a crash shopping list
Focus on the quality stocks
This is the key. You cannot have a shopping list full of penny stocks or the very stocks that have catalyzed the crash. They are likely to be stuck in problems like over-ownership, leverage, mistrust and fundamental problems. Avoid them in your shopping list.
Have a target price to enter
Creating a shopping list is one part of the story. It is also critical to have a price target in place. You can conduct a stress test and use historical charts to arrive at a broad price range to enter the stock. That surely works.
PHASE OUT YOUR BUYING; DON’T CLUSTER IT
Don’t keep your shopping list too narrow. Have options and alternatives built into your shopping list. Also don’t invest in one go. Try and phase out your entry so that you get the best average. In a bounce back, all these things matter. Take care.
“I prefer to be fearful when others are greedy and be greedy when all the others are fearful” – Warren Buffett
WHY CREATING A CRASH SHOPPING LIST IS SO TOUGH
- Separating the wheat from the chaff is the biggest challenge. Any market carnage destroys value across the board. The challenge is to distinguish the stocks that are showing signs of value and stocks that are showing signs of weakness. An example would be HDFC Bank versus DLF in 2009!
- Most investors are reactive rather than proactive in a crash. The primary focus in a crash is to ensure that your losses are funded, your margins are covered and your capital is protected. You rarely focus on creating a shopping list. This is true across most classes of investors.
- The media and the analyst community tend to play spoilsport. Both these communities are prone to excess on either side. You will hardly find analysts screaming value even at dirt cheap valuations. It takes a lot of guts and stomach to take a decision against the trend.
- More often than not, your charts let you down. Charts track momentum and are rarely identifiers of value. When the momentum and volume bias is on the downside, the charts will hardly give you a buy call. It needs a brave man to take a fundamental view, when charts are discouraging.
- The bottom is so hard to catch. That is the crux of the problem. We wait for the rock bottom, which is impossible to identify in practice. We miss attractive opportunities, whereas we should have been happy buying close to the bottom. You need to get your basket out fast.
- The biggest problem is liquidity. A bear crash tightens liquidity in a variety of ways. Exchanges tighten margins, brokers give no leeway, funding virtually vanishes and hence investors are unable to capitalize on market downturns. Liquidity makes it a lot tougher.
Creating a shopping list in practice
Ironically, we lose out on buying opportunities because we lose out on selling opportunities at the top. No, you do not need to sell at the peak. Keep a P/E target and exit. You may not exit at the peak but you will at least be prepared with liquidity to capitalize on the market correction. It is the liquidity that gives you the much needed freedom and confidence to keep your shopping list ready and execute it in the market.
Once you have the requisite liquidity, keeping a list ready is the next challenge. Avoid the stocks that caused the rally; they will invariably cause the crash. Avoid stocks that are in a prolonged down-cycle. Focus on the quality stocks, with robust earnings, tested business models and sound management. They are normally the ones to bounce back at the first sign of the market bottoming out. Eventually, price is what you pay but value is what you get. So go out and catch value.
TAKEAWAYS FROM THE “CREATING A SHOPPING LIST” DEBATE
Some of the finest investors in the game like Warren Buffett, Peter Lynch and David Einhorn have always kept a shopping wish-list ready. They have stuck to long term value and never been in a hurry to buy. A classic example is how Buffett bought financials at the height of pessimism in 2009 and eventually reaped the benefit. As the old say goes, “Performance is temporary, but class is permanent”. It is these classy companies that you must have in your shopping list.
As Bernard Baruch famously said, “The main purpose of the stock market is to make a fool of as many people as possible”. But in the long term, quality and value will win the game. Those investors who are able to stay liquid in a crash with a ready shopping list will reap the benefit. After all, in a market that is built on hope, panic can never be permanent. It will eventually give way to optimism and help the market turn the tide. That is when your stock market shopping list will pay off handsomely.
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