Beginner’s Guide to Investing: Part 1/2 May 12, 2020

For the past 2 months, the stock market has been unpredictable. We have seen large volatility and a major correction in the stock market across global stock markets and indices. The decrease in demand for oil amid the COVID-19 pandemic has resulted in a plunge in oil prices.

In this first article, I will attempt to share with you my insights and answer the commonly asked question that investors may have.

During a market crash, should investors buy, hold or sell their stock?

Fear is likely the key factor in a market crash. Fear will weigh on the market’s sentiments, and panic selling will exacerbate this downward spiral. If investors have not put in their money, it is advisable to stay on the side-lines until there is confirmation that this dip is over. If a long-term investor believes in the long run potential of a company, they may choose to hold and ride out till recovery. On the other hand, a short-term trader may decide to sell and cut their losses and choose to invest on another day.

At this point in time, if you belong to the pool of investors who are wondering whether to cut your losses or to hold on to your shares till recovery, the decision that you have to make is most likely one with painful repercussions. This is why it is very important to set a stop loss when investing to minimise losses during a crash.

If you belong to the pool of people who have not yet invested but are contemplating to enter the market, you have to ask yourself whether you have the discipline and capability to hold your shares for a long term. You must be careful not to catch a falling knife in the market, and in the worst-case scenario, be prepared to see a paper loss on your portfolio, before the stock market reaches its true bottom.

We do not know how far and how long this COVID-19 pandemic will last. Hence, we should avoid certain impacted industries like tourism, aviation and oil until we see for certain that the market is recovering. One can also look at companies with a healthy cash flow balance, as they will have a higher capacity to ride out during this turmoil.

Is there any way to foresee a stock market crash?

The stock market movement is more or less a reflection of the health of the economy. In theory, the economy will cycle between expansions and contractions, and these business cycles can be used as a guideline to gauge the next expansion or contraction phase.

However, to accurately pinpoint a market crash based on these cycles requires a skill that is hard to master. Some investors may attempt to forecast a stock market crash using different technical indicators such as moving averages, volume and wave counting but technical analysis is based on the past data of the market and may not be reflective of market conditions going forward.

In the next article in this series, we will touch on some simple technical analysis and indicators in an attempt to study the market trends and fluctuations.

How should I build up a defensive portfolio? Is it advisable during bullish times?

Investors tend to refuge in safe-haven investments during a crash. Precious metals such as gold and silver tend to outperform during periods of uncertainty. Another safe-haven asset to consider is bonds, as they can generate a steady flow of income through coupon payments. Investors can also look at adjusting a portion of their portfolio to stocks that are ‘defensive’ or likely to benefit from policy measures arising to counter the impact of COVID-19 pandemic.

On the contrary, during a bullish market, investors tend to feel positive and more willing to go for riskier investments. As the market recovers, the performance of riskier, non-defensive stocks will likely outperform the relative performance of defensive stocks. Upon recovery, the performance of safe-haven assets such as bonds and gold will fall due to an increase in market sentiment and demand for better performing stocks.

Till the next time, stay safe!