Investor myopia is a fascinating phenomenon. Do you remember last month? The ASX had lost the better part of 9%, shedding all of its gains for the year. The headlines of every financial publication trumpeted the looming correction…or possible market crash.
And volatility was the buzz word of the day. Fear gripped the markets and many investors ran with that emotion and sold out of perfectly solid stocks.
The following is from an October 14 article in the Wall Street Journal, less than one month ago:
‘The index, known as the VIX, peaked at 24.64 on Tuesday—a level last seen in July 2012—marking an 80% increase since the start of the year and a 50% increase this month alone. Since hitting its 52-week low of just under 10.28 in July, it has more than doubled to well above its 20-year average of around 20.’
The VIX, by the way, is what’s known as a volatility index. It tracks the S&P 500, and investors and analysts use it to measure perceived market risk. You’ll often hear it called the ‘fear gauge’.
Investopedia offers the following definition: ‘VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.’
Take a look at the chart below. You’ll see (if you look very carefully) the VIX actually peaked a day after the WSJ article quoted above, hitting 25.27 on October 15. That was up from 15.11 just seven days earlier, on October 8.
If anything lower than 20 can be seen as complacent, investors were certainly enjoying some tranquil times in August. And the numbers have dropped off again since October 15 — down to 13.02 on Wednesday. And if the lack of recent headlines is any indication, market volatility has once again slipped from investors’ myopic radars.
Until, of course, the next time.
Source: Yahoo Finance
Why is this important? Because fear is just as dangerous as greed when it comes to making sound investment decisions. When markets become more volatile, and when some of your investments are posting losses for several weeks running, the impulse to cut and run can be overwhelming.
Of course, at the end of the day, whether you choose to sell or not is entirely up to you. But there’s a reason why we recommend that members of the Albert Park Investors Guild adhere to the principle of trailing stop losses. This takes the emotion — the fear and the greed — out of your decision.
If a stock hits its trailing stop, it’s time to sell. Not sooner…driven by fear that it’s been falling and will continue to fall. And not later…driven by greed that it’s fallen as far as it possibly can and will now surely bounce back.
If you’re looking for more details on stop losses, Meagan wrote an article detailing the importance of adhering to trailing stop losses in The Daily Reckoning a few weeks ago. To review that, click here.
Taking fear and greed out of the picture
Taking fear and greed out of the picture
Let’s have a look at a stock from one of our portfolios to see this strategy in action.
I can’t reveal the name of the stock here — that’s for Guild members only — but let’s call it Company X. When Investment Director, Meagan Evans, added X to the Guild’s World Dominators portfolio on August 8, it was trading for US$74.23. By August 26, that had climbed to $77.24. Then, along with the broader market, things took a turn for the worse from September through the middle of October. On October 15th, Company X was selling for $70.30, down 9% from its peak on August 26 (ignoring exchange rate fluctuations).
Now I won’t lie to you. A 9% drop in share price in roughly six weeks time is not insignificant. And many mainstream analysts were predicting that this was only the beginning of a much more severe stock market downturn. If they’d been correct, that might well have taken Company X’s price even further down.
Today it looks like those analysts were sounding the market crash drums prematurely. Markets around the globe have staged significant comebacks.
Will that continue? I don’t know. No one knows. There are simply too many variables at play to accurately predict where markets will be next month, let alone next year. The best you can do is guess…and when it comes to your financial well-being, guesswork should never be part of the process. And neither should your emotions.
Which brings us back to Company X. If you’d allowed your fear to spike (as so many other investors did), you may have decided that a 9% fall in share price signalled it was time to sell. After all, things could get even worse. And that’s a scary thought!
But the fact is they didn’t. And if you stuck to your 25% trailing stop loss strategy, then you’d still own Company X today. Though it’s yet to regain its August 26 high, it’s back up about 3.5% from its October 15 low, when fear drove many investors to sell. And with the solid fundamentals behind this company, we’re confident it will surpass its previous high and continue to pay handsome dividends.
The Guild’s portfolios are designed to grow our members wealth over the long term. When the market gets a bit stormy, I like to remind them, hold onto your hat.
For The Daily Reckoning Australia