Monday was another painful session for the S&P 500 with the index falling to the lowest closing level since early October.
Putin moved Russian troops into eastern Ukraine and the West responded with a small list of economic sanctions. In fact, the sanctions were so modest that stocks actually rallied on the news. (Investors cheered that Russian energy exports were excluded.)
Okay, so stocks are at the lowest levels in several months and a big chunk of the bad news is already out there. Does that make this a good time to be selling stocks “before things get worse”? Or is this a better time to be looking at these discounts as the next golden opportunity?
While it never feels this way in the heat of battle, risk is simply a function of height, meaning the lower we go, the lower the risks have actually become.
Go back a month and a half when stocks were setting record highs and everyone was “fat, dumb, and happy”. With hindsight as our guide, how risky were stocks at that point? Yeah…
Fast forward a few emotional selloffs later and how risky are stocks now that they’re down 10%? Hmmm…
At the very least, we can say stocks are 10% less risky simply because they can only fall another 90% before hitting zero.
But we know the index cannot fall to zero, so current risks are actually a lot lower than that. (If the index falls to zero, civilization has ended and money is worthless, so our portfolios don’t really matter anymore.)
If this selloff falls 15% before bottoming, that means nearly 70% of the risk has been removed from the market. Does that sound scary? No, not really.
And more than just figuring out the rapidly diminishing downside risk, are people actually worried about what’s going on in Ukraine? Are they selling stocks because they think this crisis on the other side of the world will wipe out the American economy? No, of course not. No one thinks that. Instead, they are selling for no other reason than they think other people are going to sell.
I’ve been doing this a long time and doing something simply because you think someone else is going to do something is a really bad trading strategy.
Savvy traders buy and sell based on what the market is doing, not what they think other people are going to do. And down 10% on news that really doesn’t affect US markets is a far better time to be eyeing these discounts than rushing for the exits.
I’m looking for the next bounce and you should be too. Stocks closed pretty well Monday afternoon and there is a good chance this strength will continue Tuesday. Hesitate and these buying opportunities will be gone before you know it.
Start small, get in early, keep a nearby stop, and only add to a trade that is working.
Follow those simple rules and buying bounces is a low-risk/high-reward trading strategy.
Jani Ziedins (pronounced Ya-nee) is a full-time investor and financial analyst that has successfully traded stocks and options for nearly three decades. He has an undergraduate engineering degree from the Colorado School of Mines and two graduate business degrees from the University of Colorado Denver. His prior professional experience includes engineering at Fortune 500 companies, small business consulting, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two children.