Have you ever gotten into an argument or fight with someone who goes from calm and rational to nuclear in an instant? It’s scary.
In my life, the few scraps I’ve gotten into took the typical course. A heated debate leads to name-calling and threats. Finally, one guy pushes the other and it’s on.
But I’ve always walked away when the party with whom I’m having a simple disagreement explodes out of nowhere. That person is unstable, and you never know what’s going to happen.[ad#Google Adsense 336×280-IA]That’s how the market felt on Monday.
It was not an orderly decline. If it was, it still wouldn’t have felt good – but it wouldn’t have been as downright scary.
The sudden plunge, attributed to the slowdown in China, was exacerbated by high-frequency traders’ computers dumping shares all at once.
It left the market out of control as there was no human to analyze what was going on and figure out a way to restore the market to order.
In the old days, when specialists still traded on the floor of the New York Stock Exchange, if there were an overwhelming number of sell orders, the specialist might delay the opening of the stock until they were able to make an orderly market.
That doesn’t mean the stock wouldn’t plummet or that crashes could be entirely avoided, but it would eliminate these computer-caused flash crashes that we’ve seen a few times over the last several years.
It also didn’t help that many of the online brokers were down or impaired during the frenetic trading of the morning. I know that I was still getting very slow data even in the afternoon.
How to Handle a Crash[Earlier in the week], in Wealthy Retirement, I outlined several things you should do when markets tank. These included sticking to your trailing stops (as Matthew Carr advised yesterday). I can’t tell you how many emails I receive from readers who think it’s better to abandon their stops during crashes because “the market always comes back.”
It often does bounce the next day. But stops are a tool to manage risk. The last thing you want to do in a crash is ignore risk management. You could end up losing a lot more than you ever expected.
Protecting your capital is vital when markets crash. But…
What if you could make a quick 10% or 20% when they do?
Josh Brown, who writes The Reformed Broker blog, recently discussed a unique – albeit speculative – way to capitalize on the panic of a crashing market. When markets behave like they did Monday morning, put ridiculously low buy limit orders in and see if you get filled.
For example, say you were interested in biotech giant Celgene (Nasdaq: CELG), which closed Friday at $119.05. You see the market is in an all-out panic on Monday morning, so you put in a buy order 20% below Friday’s close at $95.
You might think to yourself, there’s no way that bid will get hit…
On Monday, Celgene opened at $104.28. It then swiftly fell to a low of $92.98 as the computers and panic drove the market lower. Your $95.25 bid would have been filled and you’d have owned the stock 20% below Friday’s close, with no change in the company’s fundamentals.
When Celgene quickly bounced back and closed at $113.38, you would have been sitting on a 19% gain – all in just a few hours.
Starbucks (Nasdaq: SBUX) is another example. The stock closed at $52.84 on Friday. If you put a bid in 20% lower at $42.27, you probably would have gotten filled, as the stock bottomed at $42.07. It closed at $50.34 on Monday – another 19% gain.
There is nothing magical about the number 20%. I’m just using that as an example of a big discount to the closing price of a stock. You may decide 10% or 25% is better for you.
The important thing to remember is that you should use this strategy only with stocks that you’re happy to own even if prices fall further. Additionally, be aware that in a crash, stocks can in fact go lower.
Just because your stock is down 20% when you buy it doesn’t mean it can’t fall 40% on the day/week/year.
In fact, sometimes crashes are only the beginning of down moves. So even though you’re getting a 20% discount, you could still lose money in a bear market.
But I like this technique, particularly for some dividend payers that I’ve had my eye on. Imagine if you bought Verizon (NYSE: VZ) when it was down 10% yesterday. You’d now be earning a 5.3% yield. Or you could have gotten a 3% yield on JPMorgan (NYSE: JPM) if you had bought it when it was down 10%.
Just be careful; this strategy is not for the timid. But if you’re willing to own a stock lower, even if it continues downward, you might find yourself up a quick 10% or 20% by putting out ridiculous bids that you think will never get hit.
Source: Investment U