How to protect yourself in a sell-off  

You don’t need us to tell you that the ASX has had a pretty volatile year.

March 2020 saw the biggest monthly loss on record, including the biggest daily percentage fall ever seen.

This was swiftly followed by the largest monthly gain on record in April.

With more economic uncertainty on the horizon, it doesn’t look like the rollercoaster is going away any time soon.

You may have done well from this period, but as we all know, past performance is no guarantee of future results.

So how do protect yourself in these times of whipsawing share prices and the possibility of a sudden turn to a bear market?

1. Have a strategy.. and stick to it

Even the most battle-hardened trader can struggle to take emotion out of decision-making.

But making decisions based on what you are feeling at that moment can be a recipe for making the wrong call at precisely the wrong time.

Having a pre-defined strategy can be key to ensuring that you don’t make emotional decisions that leave you on the wrong end of market movements.

A core consideration when defining your strategy is the time frame for any investment. If you haven’t defined this when entering a trade, then you could be leaving yourself open to buying and selling at precisely the wrong time.

The big question to answer is: are you a trader looking to profit from short term price moves, or an investor that plans to leverage a longer time horizon?

If trading short term, it can be a good idea to pre-define your entry and exit points so you know exactly when you’ll sell, whether the stock goes up or down in value. Short-term traders may also reconsider their position sizing in particularly volatile times, for example reducing portion size will reduce volatility in a portfolio

Longer-term investors are usually less concerned with the day-to-day volatility and more focused on the long term opportunity of a company, so staying across across a company’s market opportunity, competitive advantage and balance sheet strength can be key to making decisions, regardless of any short-term price volatility.

Most longer-term investors will likely hold through market downturns and may even add to their positions if the price becomes attractive enough. If you’re a long-term investor and are setting a stop loss for a long-term investment, it can be a good idea to use a wider range to allow for volatility in the market, to ensure you don’t exit accidentally following a short-term drop.

The important thing is to have thought about these questions in advance, rather than thinking about them once you are in a trade and the market is moving against you.

2. Stay across your stocks

This may sound like a given, but it’s important to ensure you’re kept up-to-date with your holdings so that if things go south, you can take action when you need to.

This means staying informed with news about the company itself, its trading volume and of course price.

Alerts are good, alerts using real-time data are better.

Your trading platform should allow you to set alerts on price, volume and news and it can be a good idea to set an alert at a price that is your exit point so you can put your strategy into action when the time comes.

3. Understand market cycles and how it affects trading psychology

When you’re in the middle of a sell-off, it’s easy to lose sight of the fact that downturns a natural part of the market cycle.

One of the most difficult things to deal with during the entire market cycle are the stages of trading psychology which no trader is immune to.

When the market is on an upswing, there’s optimism, enthusiasm and even exuberance in the air – a heady mix that can mean that traders get greedy and the market overheats. This can be the highest level of financial risk as the market peaks and there are more buyers than sellers.

As the market inevitably starts to roll over there can be anxiety and denial as previously ‘good’ decisions start to look ill-judged.

This can be followed by ‘capitulation’, where traders have to sell to relieve that excruciating pain that they’re in. 

This is the point of maximum financial opportunity – where non-emotional institutions are accumulating shares and buying futures contracts for the recovery that most likely is forthcoming.

As people sell out of positions, prices reduce and the markets starts to recover. Traders who sold near or at the lows realise they’ve made a terrible mistake and become despondent. Not a great time.

Finally, as the market slowly recovers, investors become hopeful again and start to buy – the beginnings of a rally which kick-starts the next market cycle.

Traders who succumb to the emotional roller coaster and make decisions based on fear and greed will likely end up losing money.

Those who are able to stick to their pre-defined, high probability strategy will be more likely to be able to time the market more effectively, rather than making poor decisions based on emotion.

4. Keep some powder dry

In a bear market, stocks of both good and bad companies tend to go down, but good stocks are likely to recover and get back on the growth track.

A decrease in the price of a good, profitable company therefore presents a buying opportunity… But only for those who are in the position to take advantage of it.

Market downturns can produce great buying opportunities for the prepared investor. It can be a good idea to keep a watchlist of companies you’d like to own and do the preparation work in advance so you’re ready to act when the opportunity presents itself

Next, to ensure you’re able to pick up those relative bargains, ensure you keep some capital ready to be deployed when others are panicking and opportunities arise.

This cash also acts as a bolster against volatility in your portfolio, which can be important in time of uncertainty.

The most famous proponent of this is Warren Buffet. Berkshire Hathaway currently holds just under 39% of its assets as cash or cash equivalents, ready to take advantage of opportunities as they arise.

5. Be ready to take action quickly

Anyone investing in equity markets should expect considerable volatility and have a prepared plan of what they will do when it happens. When the time comes to take action, you want to be able to do it quickly.

Ideally this means not fumbling between different websites to review updates and place trades. Not waiting until you are in front of a computer before taking action. Not trusting a platform that has a history of falling over in periods of high volume.

Marketech focus can link all of your accounts within the same platform (e.g. SMSF, individual account and family trust account), has built-in real-time news and alerts and allows you to rapidly sell and amend on the chart from any device.

Enter your details below to try the platform and ensure you’ve got the best possible tools you need for any trading conditions.

This content does not constitute financial advice, however any advice implied to be provided is general and does not take into account your objectives, financial situation or needs. You should consider whether any advice is suitable for you and your personal circumstances.