What would you do in this theoretical example?

[CJ]

All the responses have said don't buy in a downtrend, wait until it is all rosy and it's in a bull market.

However, this could be the case in the theoretical example and we wait too long as it is back up to $12.

Downtrend and bear market are different. If it is "back up to $12", then surely the down trend for this stock (maybe not the market) has ended.

[Lizard]

Never be surprised at how far the market can take a stock from your valuation... nor how far a meltdown can move your valuation once the fall-out bites the real economy. Back in 2008, it was quite possible the market would take your share to $3...

It is fairly straight forward to recover 30% losses - if you buy at $10 and it bottoms at $7 you can probably shrug. However, it becomes much more difficult to recover from 50%+ losses, particularly if you have no new capital to invest at that point.

When we had the last meltdown from Dec 2007, I used ASX data from the Market Analysis database to look at returns to November 2008 for all ASX stocks (ignoring dividends). The average fall in share price over 1822 shares was 53.6%. Only 75 stocks (4%) made gains. Of those that made gains, many were totally illiquid and very low market cap - two thirds of these had a market cap of less than $20m prior to the fall.

Note that this analysis didn't track all the way to the bottom, which occurred in March 2009.

As per some previous analysis I'd done on the 1987 -1991 falls in NZ, the message is to not underestimate how broadly and viciously the market can fall in a bear market! If you lose more than 50%, you will need to make more than 100% to recover... how many years does that normally take?

Having said that, it became clear that not all stocks bottomed at the same time. From my own experience, some stocks bottomed quite quickly and selective buying paid off. In particular, measures like Price/NTA and Price/Sales Revenue were a good indicator at this point and a good screening tool if looking to buy in early. Note that "screening" should be just that and doesn't negate the importance of further due diligence on debt servicing ability, profit forecasts and management quality.

Ideally, it seems a good idea to ruthlessly exit the market on a bear market, wait 3-6 months and then start looking for extreme value stocks. However, this is easier said than done, as a bear is only truly obvious in the rear view mirror, by which time losses have occurred and would simply be crystallised. Hence Phaedrus use of market indicators to "tighten all stops" on his portfolio as the mechanical application of "ruthless".

[cyclist]

B2I,

Good question! Here is what I do:

- What's the reverse of a stop loss? Answer: A Target Buy.
- Set your stop loss (sell) to get you out of a stock when the tide of selling has moved against them
- Set you Target Buy to get you into a stock when the tide of selling has stopped

(etc, see belgarion's post above)

This strikes me as a very clever approach. Thanks belgarion, I'll file that idea away. The difficult part would be to decide how closely you wanted to shadow the falling price. Too close and you might trigger a buy too soon. Too far away and you might buy a little higher than ideal.


p.s. I had to look up how a "target buy" works. From the ASB website, for those like me:

"Target Buy: Indicates that a buy order should be activated if a share trades only at the selected price. Setting a target price enables you to indicate a level at which a buy order should be activated and placed on the market. The target order will only be 'triggered' if the share in question trades at the indicated price. A limit price can also be indicated which means once the 'trigger' has been activated, the shares will be purchased at no more than this limit price. The target order facility is aimed at traders who believe that if the price of a stock reaches a certain level, the share price will continue to rise. The target price is always above the current market price".