Page 25 - DIY Investor Magazine - Issue 23

THINK I’M OVER DRAMATIZING THESE CASES? THINK AGAIN, THEY’RE ALL TOTALLY PLAUSIBLE.
Scenario 1:
Many get put off investing by a bad experience before they’ve even really got started; quit and miss out on a brilliant way of creating wealth.
Scenario 2:
Others get caught by age and infirmity; fear of losing capital they can no longer replace results in inertia, destroying the wealth they worked so diligently for.
Scenario 3:
This takes nerve - you have to have faith in your system and keep going. Like going into a corner too fast in your car, brake halfway round and the ditch beckons, keep the power on and it should work out - unless you’re going stupidly fast.
A quotation from Winston Churchill sums up perfectly what to do when things go badly wrong – ‘Keep calm and KBO’; KBO stands for Keep Buggering On:
• Keeping calm and carrying on is easy to say, but less easy to do when your capital is at risk; but savage market declines are a fact of life and inevitable – accept it.
• Have a clear idea of how you will handle them; there are a number of ways, all with pros and cons.
• Wherever you are on your investing journey, know how you will handle the situation in advance and then deal with it.
My take is that there are four main ways an investor can handle anything from a smallish correction to a full- blown bear market:
Masterly Inactivity: Do nothing as you expect your portfolio to fully recover with the market.
Scale out of Positions: Sell out progressively at pre- determined points, go into cash and subsequently buy back at lower prices.
Hedge: Take a short position in the index (or indices) that most closely correlate to the portfolio; the fall in the portfolio’s value is balanced by the rise in the value of the short.
Pound Cost Averaging: Add extra money to investments at set regular intervals; buying into a falling market, the average entry price is lower than it would have been and thus profits are greater when the market recovers.
A deep dive is beyond the scope of this short article, but the advantages and dis-advantages of all four are discussed in detail in various articles, podcasts and videos on our website https://www.thenimbletrader.co.uk
So, why do market ‘crashes’ happen and how do they often start? I’ll run you through my method to protect my portfolio from falling prices.
WHY DO MARKETS CRASH PERIODICALLY?
There is always an underlying fundamental reason – possibly as trivial as the ‘need’ for a correction after a period of excessive optimism, to a full-scale war, not in a faraway country no-one has heard of, but next door.
I’m endlessly fascinated by the markets - they are mostly ‘instant’ execution’ and inherently unstable because
it doesn’t take much of an imbalance between buy or sell trades to move prices and once they are moving momentum can really kick in.
Sentiment is so unpredictable, sometimes the market simply shrugs off either good or bad news, other times something of no great consequence causes a major panic; markets are unstable so they fall over every so often.
‘IS THAT LOGICAL? NO, BUT IT’S THE WAY THE MARKET WORKS’
25 DIY Investor Magazine | Oct 2019