News / Inter Market Analysis

Befriending Mr. Bear By Frank Chiu October 09, 2008

What to do now?

As per the advice of most writers in finance websites, its time to invest in bonds and other safe investment instruments. And tighten your belts until you turn blue. I can’t quite relate though to this “fight to safety/quality” term that they’ve coined. What’s very “qualitative” with earning 3-5% per year in short-term debt instruments (i.e., bonds) when it will just be eaten up by infation? This also doesn’t take into consideration the gas that you’ll be wasting on your trip to the bank. How about 8-10% in long-term, 5- to 10-year bonds? No problem here, just as long as you know what you’re getting into and that your money will be tied up for a long time. Assuming the stock markets turn bullish and you want to take part in it again, you can actually sell your bonds (even way before its maturity date) via the secondary market. This though doesn’t assure you of the original principal that you put in, hence my reluctance to tie up money in these debt instruments. This should be another separate story though.

But we are missing the point here.

I want to bring up these three tenets of technical analysis, proper appreciation of which I think should help not just technicians but also traders and investors of all shapes and sizes:

1. Price discounts everything.
2. Prices move in trends.
3. History repeats itself.

The frst two are obvious by now. We see fear, panic, indecision and cluelessness in market participants just by looking at the stocks’ price actions. The market’s trend right now is very much obvious. What I like to zoom in on is tenet number three – “history repeats itself.”

If we say that history is repeating right now and we seem to not learn from previous mistakes (e.g. market bubbles, Wall Street greed and “irrational exuberance”), it is very important to realize that we should also say that history will repeat in terms of markets going back up on its feet again. What happened after the Black Monday crash of 1987? How about the Savings & Loan crisis of the 1980s and 1990s? Anybody care to check out the stock performance after the Dot com bubble and the September 11 terrorist attack?

Problem is, we most probably will still not learn from previous market rebounds. Why? People turn off the television if the bears are in town either because (1) they want to avoid feeling more pain and anguish from seeing their stock portfolio plunging everyday, (2) they see no reason to look at plunging prices and they’d rather hold on to their favorite stocks, (3) assuming they’ve cut their losses, their portfolio is now bleeding dry and they see no reason to take an another beating or two, or (4) worst of all, they only rush back once the bull market is in full swing because they need an awful lot of time convincing themselves that the bears are gone. By this time though, the market is almost at the point of peaking again.

History repeating itself? – buy at market high (again!) because you want to catch the runaway train and you’re thinking that the stock markets will grow indefnitely once again(!) and then sell at a loss (again!) once the second bear arrives. Vicious cycle, anybody?

Befriending Mr. Bear I can’t help you with the money that you’ve already lost. What I can do is drive home the point that you have to treat the bear market as your friend. The fact that you’ve lost money should be enough reason why you should listen to Mr. Bear’s teachings.

I’m not saying that we need to buy the stocks that are looking more and more cheap as the day goes by, do average down and bottom pick until it hurts. What I’m saying is don’t sleep on the market while it is plunging. The best time to learn how to trade is in a bear market setting. You get to learn mistakes that other people are making. You get to feel greed, fear, panic,nervousness and all and get to process them constructively. You get to learn how to control your emotions. You’ll get to appreciate why having an objective trading system is important.

It’s very easy to proft in a bull market. As they say, everybody becomes financial wizards and geniuses in a bullish market as everything they buy will more often than not turn to gold. You don’t learn anything from that. Per experience, most people would strike big in a bull market, only to fnd their profts (plus principal) go down the drain once the bear market sets in.

Study feverishly during bear markets. Tighten your belts a bit so that you can increase your savings. Pour back all your cash (don’t touch your children’s education funds though!) and apply what you’ve learned once the bull markets return, knowing that you’ve imbibed Mr. Bear’s teachings and you’re more seasoned and ready to grab Mr. Bull by his horns.