Lately, I had some free time on my hand, so I have been watching videos from local financial content creators on YouTube. This is the first time I come across the concept of "Crash Buying", which essentially means to buy more of a stock/fund when its price drops to a certain level due to a market crash.
This behaviour struck me as odd, as this is the classical "catching a falling knife" scenario in standard finance. While it is not flawed, this technique is non-ideal because it makes the following bold assumptions:
1. The stock/fund price did not fall because of permanent damage to its business;
2. The price eventually recovers above your purchase level;
3. One has sufficient dry powder to purchase meaningfully at each level;
4. One has the mental fortitude and discipline to buy each time the level is hit.
Here is an interesting thought experiment. The graph below shows the S&P 500 Index during the COVID-19 pandemic after it dropped 10 percent (right-hand side of the chart is covered to simulate point-in-time):
At this point, do you have the courage to pull the trigger? Note that the 10 percent drop was accomplished in a matter of *days*, not weeks or months. So fast, so furious! Questions abound: Am I crazy to buy now? Will it drop more? When will it recover?
Assume that you pulled the trigger, and the market continued to do its thing. A plunge of 20 percent was hit:
Enduring the gut-wrenching paper loss, you wonder if you did the right thing. At this point, more questions pop up: Do I buy more? Or wait? Is the market going to sink deeper? So many questions! So much uncertainty!
Like in a nightmare, the market continued to tank after your second purchase. A drop of 30 percent was established:
Your account is now deep in the red. You feel that you cannot take the stress anymore. At this point, you are questioning the strategy. Doubt clouds your mind as you ask yourself:Do I still deploy my dry powder? How much more pain must I endure? Is the world coming to an end?!
So you see, it is NOT EASY to adhere to the Crash Buying strategy. The fear can be destabilizing. The pain is real as you provide liquidity to the market when institutional investors are scrambling for the exit.
I would like to propose an alternative framework, which may be easier on the stomach. I call it "Crash Buying in Reverse", for lack of a better name.
The first step is to simply WATCH as the market crashes and burns. We DO NOTHING until the price bottom is established, when the selling is all done and buyers start to tiptoe back into the market.
Wait until the market rises 10 percent from the bottom. Then we deploy our first tranche of firepower:
Note that at this point, we still cannot be certain whether the market has recovered, or it is merely a dead cat bounce. So we do not deploy all our capital. Just a starting portion that one is comfortable with.
As the recovery takes hold, the market rises 20 percent from the bottom. This is the point when we deploy our second tranche of firepower:
The market has lifted off significantly from the bottom. Optimism is returning. Institutional investors start to load up for fear of performance drag against the benchmark. As more buying takes place, we continue to wait until the next level is hit - at the 30 percent rise from the bottom. We then deploy our third tranche of firepower:
This strategy has a few advantages:
Firstly, it minimizes the guesswork of trying to pick the bottom. We buy only when there is a clean sign of upturn.
Secondly, it eliminates the anxiety of waiting for the market to bounce back above our purchase price. We are buying into strength. If the market reverses downward along the way, we re-start the strategy from afresh.
Lastly, it follows the theory of momentum investing, where we bet that "winners keep winning". In this case, the premise is that an up market will keep on going up unless acted upon by a downward force (think Newton's first law of motion applied to stock markets).
Fun fact: If you had bought at the 10 percent drop, you would have waited 93 days before the market recovered to your purchase level. About three months, not too bad. Then again, at the point of buying, you did NOT know how long you have to wait!
Now, I would like to categorically state that the above information is for education purpose only, and does not constitute investment advice. I have not backtested this alternative framework against all crashes in history (though I am fairly sure this strategy does not require Panadol during execution). As a fellow investor, I am just providing another perspective for your consideration.
Happy investing, my friends!
This behaviour struck me as odd, as this is the classical "catching a falling knife" scenario in standard finance. While it is not flawed, this technique is non-ideal because it makes the following bold assumptions:
1. The stock/fund price did not fall because of permanent damage to its business;
2. The price eventually recovers above your purchase level;
3. One has sufficient dry powder to purchase meaningfully at each level;
4. One has the mental fortitude and discipline to buy each time the level is hit.
Here is an interesting thought experiment. The graph below shows the S&P 500 Index during the COVID-19 pandemic after it dropped 10 percent (right-hand side of the chart is covered to simulate point-in-time):
Assume that you pulled the trigger, and the market continued to do its thing. A plunge of 20 percent was hit:
Like in a nightmare, the market continued to tank after your second purchase. A drop of 30 percent was established:
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| Image Credit: Google Gemini |
So you see, it is NOT EASY to adhere to the Crash Buying strategy. The fear can be destabilizing. The pain is real as you provide liquidity to the market when institutional investors are scrambling for the exit.
I would like to propose an alternative framework, which may be easier on the stomach. I call it "Crash Buying in Reverse", for lack of a better name.
The first step is to simply WATCH as the market crashes and burns. We DO NOTHING until the price bottom is established, when the selling is all done and buyers start to tiptoe back into the market.
Wait until the market rises 10 percent from the bottom. Then we deploy our first tranche of firepower:
As the recovery takes hold, the market rises 20 percent from the bottom. This is the point when we deploy our second tranche of firepower:
This strategy has a few advantages:
Firstly, it minimizes the guesswork of trying to pick the bottom. We buy only when there is a clean sign of upturn.
Secondly, it eliminates the anxiety of waiting for the market to bounce back above our purchase price. We are buying into strength. If the market reverses downward along the way, we re-start the strategy from afresh.
Lastly, it follows the theory of momentum investing, where we bet that "winners keep winning". In this case, the premise is that an up market will keep on going up unless acted upon by a downward force (think Newton's first law of motion applied to stock markets).
Now, I would like to categorically state that the above information is for education purpose only, and does not constitute investment advice. I have not backtested this alternative framework against all crashes in history (though I am fairly sure this strategy does not require Panadol during execution). As a fellow investor, I am just providing another perspective for your consideration.
Happy investing, my friends!
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