On February 5, 2018, the Dow Jones Industrial Average incurred the largest single day point drop ever. While market dips like this can trigger emotions of fear and concern—particularly if they occur suddenly and over a very short period of time—they are not uncommon. The US stock market has a proven track record of recovering from market dips over a long enough period of time.
One key to successfully navigating turbulent markets is understanding what kind of investor you are, having a plan, and sticking to it.
If you become nervous about your investments at any time, take a breath and think about formulating a plan to weather market volatility. Once you are confident in your plan, here are a few things to keep in mind when considering buying into a dip in the market.
Long-term investing outlook on market pullbacks
Each major market move is unique, should be evaluated on its own merit, and should be viewed through the lens of your specific objectives and risk constraints. One significant factor that can shape how you approach market dips is your time horizon.
If you are a long-term investor, for instance, you might consider utilizing excess cash to establish new positions in companies you have wanted to buy and previously felt were expensive. With this strategy, it may be prudent to thoroughly analyze changes to the macroeconomic environment, business cycle, and any other fundamental factors before deciding to buy into a dip.
A long-term investor might also choose not to reflexively react and simply wait out market downturns—even the biggest and scariest of them. Case in point: In March 2009, the S&P 500 plummeted below 700, from the then all-time high above 1,500, and is now trading near 2,700. If you went into hibernation in the summer of 2007, stayed invested, and just woke up, it may seem as though markets have steadfastly marched higher without interruption.
Short-term investing outlook on market dips
Some investors have shorter investing horizons. To the short-term trader, pullbacks can present an opportunity of a different sort. Even some buy-and-hold investors who tactically trade with a fraction of their portfolio might try to capitalize on market swings. Of course, this approach comes with more risk, given that it integrally involves market timing—which is exceedingly difficult.
If you plan on a short-term buy strategy when there is a market dip, you might also consider a variety of technical analysis tools, such as relative strength, momentum, RSI, and stochastics, to help determine when the market is oversold or overbought on a short-term basis.
With any of these short-term strategies, it may be necessary to implement stricter risk management controls, given that the investing window is shorter and the room for error can be smaller. Specifically, if you are buying a market decline with the anticipation that it will go higher, you should plan for the possibility that the dip isn’t over. Successful planning may involve knowing how you will exit a trade quickly to help preserve capital.
One of the most common ways is through the use of a stop order or a trailing stop order. This strategy can be particularly helpful during market dips—where you aren’t sure where the bottom may be. Of course, stop orders are not price guarantees, and may provide limited protection during market declines.
For more flexibility, consider a conditional order, which can be used to trigger an exit to the position you are in based on any number of external factors. Fidelity offers tools like Trade Armor(R) to assist in taking emotion out of the equation through the use of orders to manage the potential profit and loss targets on a trade. Advanced, knowledgeable traders who are willing to accept the risks involved may even consider using options to hedge their positions.
Another option is to simply wait out a market dip. When markets become less volatile, you might resume implementing your short-term strategy.
Make a plan
Time horizon isn’t the only factor to consider. When you are building and updating your investing plan, you may want to account for how you will respond to sharp price moves based on your portfolio’s overall objectives, tax constraints, liquidity needs, and risk tolerance as well.
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