After hibernating for months, the stock-market bears came out of their caves on July 19. That day, the Dow Jones Industrial Average
tumbled 725 points or 2.1%. The bears hit a home run — at least for a day.
As usual, everyone wanted to know why the market fell, and the analysts had prepared answers, from COVID-19’s Delta variant to the Consumer Price Index to overbought technical indicators.
The truth is that nobody knows. People have multiple reasons for selling, so it’s ridiculous to blame one event. That said, a big contributor to the decline was automatic, computer-generated selling. Once large market participants, especially algos, started selling, there was a mad rush out of the door. No one wanted to be the last one out, so retail traders and institutions sold in a panic, which got more intense as the day went on.
Technical indicators contributed as well: The weekly relative strength indicator (RSI) has been remarkably accurate in warning of a market reversal. Once RSI goes over 70 and stays there, buyers beware. After the July 26 market close, the RSI of the S&P 500
stood at 71.36 on the weekly chart — an extremely overbought reading. Does this mean that the index is going to plunge tomorrow? No one knows. But RSI is giving a clue that the U.S. market is in the danger zone.
The bad news bears can’t catch a break
Before the bears could say, “I told you so,” the next day, July 20, the 700-plus point Dow selloff was erased by a 550-point Dow rally. The bulls forgot about the selloff and returned to celebrating, and gulping glass after glass of their favorite drink, “bull-ade.” Once again, the storm passed, but this time a little fear creeped into the bulls’ psyche. Before, the only fear was the fear of missing out on the next rally. Now, many investors realize the market can actually go down.
What to do now
The next time the market plunges and you’re experiencing a variety of emotions, the following guide might help:
1. If you’re panicked: Don’t do something; sit there. Do not buy, do not sell, just sit tight. In fact, turn off the computer or other devices. Don’t fret over how much paper money you lost that day. Exercise, walk, run, swim, ride a bike. Your goal is to reduce emotions so you can get a good night’s sleep. When the market stabilizes, reevaluate what you own. Do not make any big financial decisions on days like this.
2. If you’re afraid: Take it easy. The selloff will end eventually. There is no reason to panic. Again, reevaluate what you own when the market comes to its senses.
3. If you’re unaffected: Still, check your portfolio to make sure you are properly diversified. While it’s find to not care if the market falls, be sure you are hedged for a worst-case scenario. One day there will be a bear market that will last months or years. Be prepared.
What specific actions should you take?
Now that you’ve taken care of your emotional health, there are other financial decisions you can make. Let’s take a look at some strategies and tactics that may help:
Sell if the stocks or indexes you own fall below their 200-day moving averages. Note: The major indexes such as the Standard & Poor’s 500
have not fallen below (and stayed below) their 200-day averages for a decade. When they do eventually, that is a clear sell signal.
- Create a long-term investment plan and follow it no matter what happens in the short term.
- Dollar-cost average into index funds.
- Diversify. This is the key to success in the stock market and in life. If you own only stocks, consider bonds, but talk to a financial professional (not your neighbor) before taking this step.
- Buy the big dips. This strategy still works. If you had bought the dip on July 19, you would have cleaned up on July 20. One day this strategy won’t work, but that day hasn’t come yet.
- Sell covered-call options. This is still an excellent way to generate extra income. This strategy is also ideal for disposing of unwanted stocks, and getting paid for it.
Plan for the next correction or bear market
After a 13-year bull market, the clock is ticking for U.S. stocks. While the bulls scored another victory this time, one day the market won’t reverse direction and will begin a steep correction, or worse yet, a bear market. That’s when you will be glad that you have a plan and an investment script to follow on the worst days.
Know what you own, sell to the “sleep-well” point and diversify into a variety of financial products including cash and bonds. This way, when the market plunges again, you won’t make knee-jerk emotional decisions or suffer an anxiety attack.
Michael Sincere (michaelsincere.com) is the author of “Understanding Options,” “Understanding Stocks,” and “Make Money Trading Options,” which introduces simple options strategies to beginners.