The stock market crashes once in while. A crash is both feared and loved, obviously feared by most and loved by few. Typically, a crash happens when sentiment swings from the positive extreme to the negative extreme, regardless of how significant the underlying cause is, if any.
Fortunately and unfortunately, I’ve been through a couple of crashes, in 2008, 2015 and 2020 respectively. And they all have profound impact on me.
There are many realizations after crashes you hear from here and there, but many of them become realizations only after you actually experience them. Having said that, I still think it’s a great idea to have them in mind even you have never experienced one, such that it becomes more memorable as it occurs to you. And of course, one should always learn from mistakes, and I’m sure there are plenty to be made during a crisis. Let’s go straight to my own bible:
- Stop trying to rationalize market movements, they are rarely rational. In particular, drastic market movements are largely driven by emotions which are irrational, and emotions are at the highest level during a crash. Remember, doctors, scholars and economists are generally poor investors because they are too rational.
- Valuation is important. And by that I mean extremely important. Always look at the valuation before you buy or sell, regardless how the market is doing and where you think it will go. A stock that used to trade at $100 doesn’t mean it’s cheap when it is now $10. Like wise, a stock that was $10 years ago doesn’t mean it’s expensive at $100 now. The worst thing to do during a crisis is selling quality companies at distressed valuation.
- Leverage is sexy and addictive. It brings you good times that you never forget, but it takes only one time to put a nail you in the coffin, and a crash could be that one time. “Smart men go broke three ways — liquor, ladies and leverage.” — Charlie Munger
- Quality companies will always reach new highs. Sometimes it doesn’t matter if you buy at $100 or $80, if the stock ultimately goes to $10,000.
- If diligent and right things are already done, patience is the other only thing you need. Never focus on your daily/weekly/monthly P&L. “The stock market is a device for transferring money from the impatient to the patient.” — Warren Buffett.
- Stop complaining about the rich get richer and the poor get poorer. A crisis is a chance to change that and to redeem yourself. So be prepared and do something about it when it happens. But in reality, ironically the rich gets further richer after a crisis, because many poor people are sorry losers and haters who fail to capitalize on opportunities all the time.
- Be optimistic and accept flaws. The financial market is flawed, and so are the currency system, government bodies, central banks, etc., and surely, politicians and central bankers cheat all the time to support the stock market. Deal with it and learn how to adapt. There are always flaws in your life, but it’s your choice to be optimistic or pessimistic. The stock market is a part of your life game and quitting isn’t an option, unless personal finance is irrelevant to you. The truth is, human beings always strive to be better, and they always manage to accomplish things. Therefore, you should always expect things to get better, especially over a significantly long period of time.
- The volatility during a crisis may seem to present a lot of opportunities, because stock prices move quickly. But you should be more cautious and disciplined, not less, when a crisis happens. During a crisis, sometimes you start doing things you have never done before in spite of the hurting downward spiral of stocks you own. You just feel like doing something just because watching your dwindling wealth is hurting. And usually those extra things you do won’t end well. It’s worth pointing out that most people don’t do well in short-term trading but suddenly some of them believe they could do it at the worst possible time.
- Risks are lower when share prices are lower. As simple as it sounds, it’s funny some people feel the exact opposite as share prices fall quickly. It’s also pathetic to believe risks are defined as standard deviation as finance courses at school suggest, it just shows one’s brain is not functioning properly.
- Luck plays a huge role but great investors earn their luck. Great investors avoid stupid mistakes, do their work, get prepared, and control emotions well. Bad investors don’t do any of them and blame luck when they fail, which they rightfully deserve.
- Investors bet on changes in business fundamentals over a long enough period of time, while traders profit from changes in crowd sentiment over a short period of time. However, successful traders don’t come by often, and don’t expect yourself to be one without many rounds of failure.
- Don’t try to sell at the peak and buy at the bottom. It’s not going to happen.
- In general, selling your stocks during a crisis in which fire sales are taking place around you should only happen in 2 scenarios: 1) the business fundamentals of the company is getting worse, and it has yet to be reflected in its share price, and 2) selling in return for proceeds for buying more attractive companies.
- The weighting of each stock in your portfolio should be based on relative attractiveness and it should always be adjusted as necessary. Don’t be afraid to adjust during a crisis when everything is in red.
- A crisis begins as positive sentiment peaks out. When positive sentiment prevails, people think every slight pull-back is a golden opportunity. Therefore, the most common mistake is deploying cash too quickly on its way down. You should always be calm and alert. Sentiment is not measurable, but is observable. When people around you are too busy making money from the market, you should feel comfortable with holding some cash. On the contrary, you should deploy cash gradually as people around you lose interest in looking at the market. There’s no right percentage of cash to keep at all times, just be flexible.
- A bull market begins as negative sentiment bottoms out. When negative sentiment prevails, people think every slight rally is a golden opportunity to cash out to relieve themselves. Therefore, another common mistake is getting out just when you start to recover from losses, but in fact, there’s plenty of upside to be realized going forward, that’s the last thing you want to give up.
- Everyone has limitations. And for sure, investing or trading isn’t for everyone. Some people just never have what it takes to succeed, most particularly patience. There’s no need to be ashamed.
- If the game bothers you that affects your sleep or life, take a break. When you rush it, things are more unlikely to turn out well. The casino is always open and everyone is always welcome.
- Take things seriously, it’s not supposed to be easy. Otherwise no one will go to work.
- A crisis that happens in your 30s is your best shot, by that I mean the best shot in your life. Because in your 20s, you have guts but no money, and in your 40s or later, you have money but no guts. Only in your 30s, you have both. Turn a crisis into an opportunity, and make a huge difference out of it.
“Never let a good crisis go to waste.” — Winston Churchill
