And then it becomes reality. The market is in a down-trend. And at a rapid pace. But the question now is: How could you as an investor deal with this situation? In this article, we as Binck/Saxo would like to give some guidelines to stay calm. However it isn’t an easy task in this extremely changing time, but it is possible. It is imperative to stay calm and not be guided by fear.
In this article, you won’t find information regarding the coronavirus as you find in multiple other articles, etc. No, this article is about how to handle your portfolio that has probably significantly decreased in value. But at the same time, I realise that every trader is unique and that can be seen as a reflection of how your portfolio is built. To provide you with valid information, I will introduce 4 fictional traders: the experienced long-term investor, the new/inexperienced investor that seeks risk and the experienced trader that makes use of options.
The experienced long-term investor
This investor is suffering at the moment. There is probably a good chance they didn’t see this coming. After the amazing stock market year of 2019, it seemed to continue: Low interest, the economy grew slightly, Brexit wasn’t the main topic and Trump wanted to be re-elected. This seemed like a decent foundation for another positive stock-market year. And then Corona…….
This traders’ profit will be negative for the year, but if there is no reason to sell, there are no worries. It is difficult to predict but markets will recover. The period is uncertain, it can be three weeks….or three years, but eventually, the worldwide stock index will increase. We just don’t know when. To conclude, this investor should be calm, sell nothing and maybe purchase extra stocks with the current low price.
The new/unexperienced investor
The trader that recently began has to deal with extreme market circumstances. Prices are fluctuating with x amount percentages each day and it is hard to say where the prices will stand in a week. The overload of news and the possible impact of it makes it hard to process. It isn’t easy to learn trading with the current situation. However, the ideal, beginner investor started with some important insights. First of all long-term: Despite the extreme results, the market always recovered over a period of 148 years (S&P 500).
This will happen, as history has already shown us, but the million-dollar question remains: When? But this ideal investor is aware of this, has got time and can miss his money for a longer period.
The second insight is to spread. He or she (there is an increasing trend of women in trading) started by buying shares in baskets. This can be an ETF or a mutual fund. Having an ETF or mutual fund and being in loss is still less than the individual shares. Spreading your risk works and is proving to be the case now as well.
The third insight is aligned with spreading but it is about spreading time. The available amount to invest isn’t invested at one time. It should be started (for example) with 20% of the available capital. The idea is to invest multiple times and in the end, invest the whole amount (only the available amount to invest). Normally, the main factor of starting to invest is time: for example 10% each month. But the currency, the ETF or Mutual fund can be used as an indicator as well. For example 10% lower than the last purchase price.
So there are two potential indicators for the new purchase, time or a lower price.
With this information, the starting investor has guidelines for building his portfolio
The investor that uses leverage
Many Investors get attracted by the use of leverage on diverse investing instruments. It can work rapidly to your benefit because your investments get multiplied, but it can go the other way around as well. This group is affected significantly as we have seen in the last weeks. This is because the natural habit of ‘’some’’ people is to earn a quick profit and ignore the risk. As the saying goes “Let your profits run and cut your losses’’.
As a whole, this group has been significantly affected in a negative way, but of course, there are some exceptions. For example, people that protected their portfolio with leverage or investors that have the ability to cut their losses. Shortly, this investor can make a lot of money but also lose. The profit can be high but it is aligned with higher risks. There are 2 ways to minimise the risk of working with leverage: trade in lower amounts and lower leverages. Applying those factors will decrease your risk immediately.
The experienced investor that makes use of options
Options are leveraged products that can be used defensively or offensively. Investors with so-called “puts” aim to protect their shares-portfolio- they are the lucky ones with puts in this situation. This is a defensive strategy that pays off in the moment. Also, investors with “calls” build up a buffer against the decrease. Unfortunately, the decrease in shares is higher than the received option-premium, but it makes the loss slightly better.
Negatively affected investors are the ones with puts. There are two reasons to write puts or buy stocks with a discount compared to their current price. Or to receive option-premium without being held to the (purchase) obligation, you agreed to. For investors that were seeking to buy shares at a discount, means that they received the shares or probably will receive them. Currently, they have a loss but less than if they had bought directly for the higher price. But these investors have kept in mind that they had to buy the stocks. It is unfortunate, but not the end of the world.
This is in contrast to the people who used put-options with the idea of being obligated. They are held with all their obligations and in a significant amount of cases, this amount is higher than expected. These are the traders that will be confronted with keeping their margin positive. There should be transferred extra money or the loss should be taken. Taking the loss is one of the hardest parts.
The Emotional Task
This movement will affect all traders. It is an emotional roller coaster. What may help is to have a clear overview and be aware of the possible circumstances you can face. But the important question goes as follows: Do you have the financial “time” to wait and stay calm.
If your portfolio is spread and you don’t need the money for a longer period of time, staying calm is the best thing to do. But you should be emotionally able to overcome the next price fluctuations.
The emotional load is the heaviest for the people that aren’t able to sit still and don’t have the financial freedom. They would have short nights and pray for an increase in price. These investors are confronted with the risks they took. Their visions at the time of writing the put were not established. Now the risk should be managed and that can be a pain.
The most important thing to remember is to be and stay in charge of the risks in your portfolio. Prevent the obligation to sell positions in your portfolio by, for example, having a negative margin. Think of scenarios to enable you to make the most adequate risk assessment possible. It is also important to keep an eye on the long term because better times will come.
Hard to imagine at the moment, but they will come.
Investing comes with risks. Your investments can decrease in value.
The information in this article should not be interpreted as individual investment advice. Although BinckBank compiles and maintains these pages from reliable sources, BinckBank cannot guarantee that the information is accurate, complete and up-to-date. Any information used from this article without prior verification or advice is at your own risk. We advise that you only invest in products that fit your knowledge and experience and do not invest in financial instruments where you do not understand the risks.