Wednesday, March 14, 2007

To buy or to sell stocks?

WHY did our stock market crash?

Investors need to understand that the stock market normally takes a longer time to go up than to go down,

When the market drops, as a result of fear and panic, it just cannot move down gradually.

In the recent market crash the KL Composite Index (KLCI) tumbled from a high of 1,283.47 on Feb 23 to a low of 1,110.69 on March 5, plummeting 173 points in six trading days.

The reasons behind the crash were attributed to the sharp drop of 8.8% on the Shanghai Composite Index, the unwinding of the yen carry trades as well as worries over a rapid slowdown in the US economy.

In addition, our own market correction after the KLCI's sharp rise of about 400 points without any major pullback – from 886.48 points on June 15, 2006 to the recent peak of 1,283.47 – also contributed to the downturn.

Hence, we should be aware that the KLCI took 8 months to put on 400 points, but needed only six days to lose 44% of those gains.

Apart from the China market, other regional major stock markets like Hong Kong, Japan and Singapore as well as the US market also made big losses over the past two weeks. We are not surprised by the losses, given that these markets have been making large gains over the past 8 months.

Rachel Campbell, Kees Koedijk and Paul Kofman in their research titled Increased Correlation in Bear Markets, found evidence of significantly increased correlation in international equity returns during the bear markets.

As a result of the international contagion, a big crash in any one market could lead to major crashes in other financial markets.

Hence, apart from monitoring changes in our KLCI, retailers need to keep track of movements on other major indices like the Shanghai Index, Hang Seng Index, Dow Jones Industrial Average Index and Nikkei 225.

Some traders even track the movement of the yen versus the US dollar in view of worries over yen carry trade.

Should I cut my losses now?

Some retailers tend to invest at the wrong time. Every time there is a bull market, the moment they start getting excited about the stocks and start to invest, the market collapses a few weeks after that.

In this recent market rally, we believe that a lot of retailers only started to invest one to two weeks before the Chinese New Year (CNY).

As a result of the market crash one week after the CNY, most retailers gave back all their gains while some even incurred losses.

According to Benjamin Graham, the word “intelligence” in intelligent investor “is a trait more of the character than of the brain”.

It has more to do with how investors control emotions when investing.

They must have the courage to take profit in a bull market and have the discipline to cut losses when the investment drops below a certain acceptable level.

At the beginning of the market crash, most retailers were reluctant to sell their stocks because the prices went below their recent highs.

For example, even though their cost of stock A was only at RM1.00, they did not want to sell the stock at RM1.70 because the stock's recent high was RM2.00.

To them, selling at RM1.70 means they are incurring a “loss” of 30 sen. In actual fact, they have already made 70% profit, given that their original cost was only RM1.00!

These investors, however, panic and want to sell when the market crashes further and when the stock price trades nearer to their original cost of RM1.00.

As a result, most retailers were unable to make money from the stock market because they bought and sold at the wrong time.

Is it a good time to buy now?

After a market crashes it needs to go through a period of consolidation before gathering the momentum to turn around.

Nobody can tell when the consolidation period will be over. In our local market, the recent low of 1,110.69 on March 5 may be the lowest level of the recent pullback. Ooi Kok Hwa, a licensed investment adviser and the managing partner of MRR Consulting, gives some advise on buying and selling of stocks

If the market goes against our view and starts to move up, we should not continue to be bearish if we have sold out all stocks. We must be then be prepared to buy them back.

Hence, we need to constantly monitor our country's economic development as well as the global economic outlook.

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