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Stock market shock

I'm writing this article when I was waiting for my plane at the airport.  It was a long 1.5 hours delay, then I got this inspiration.  This article is still under development and will be corrected overtime.

Stock price often related directly to a multi national and global event.  A global shock could increase the stock price 2-3 folds or even tumbles the stock price.  The latest and severe global shock, the subprime mortgage crisis's effect is still here and could stay for another few months or even years. 

The bad news is no one knows what exactly causes the subprime mortgage crisis, however.  Some people speculates that it could be the soaring of petrol price, the uber consumptive lifestyle of the Americans or even speculator's conduct.  That means that investors are faced with unknown.  This article will not explain on what causes the stock market shock.  I also can't find the what causes, all that I know is it is a series of event that is caused by and creating a by-product that is pretty complicated in an circle.  This article will explain how to avoid the shock.

What to avoid? 

  1. Stock rally

    • A very good news on one fine day might increase the stock price or even the index by substantial amount.  When the price increases in a substantial amount over a time period, e.g. 1 year, most investor will be in a euphoria, buying happy and selling happy. 

    • Example: this what happens since mid 2006 until the beginning of 2008.  The IHSH rally and reaches its highest point ever.  Buying a stock on the beginning of the rally is a good idea , since that means earning a big return when selling the stock.  But beware of other news such as the company's decline in profits.

    • Where most people got trapped:  investors usually take profit when they saw 40% increase in price.  Then after a few days, investor will usually buy the stock again, then hoping to sell when the stock price increases for another 40%.  However it is unknown when the rally will be over, and usually when the rally is over, the stock price will crash.

    • This is where most people got trapped.  When the market crashes, investors will usually hold the stock price until it goes down to the original price, therefore loosing money.

    • How to avoid this?

      • Do not follow the rally by buying more and more.  Just enjoy the wave ride with what you had.  Do not average up or buy the stock again after making a good profit.

      • Correction strategy when you had bought the stock, cut loss when the stock tumbles for 10% and keep the cash until everything goes to normal and safe to invest again.

      • The latest strategy is the hardest.  If you had the stock on your possession, just do nothing and enjoy the wave!

  2. Stock price tumbles

    • A bad news will crash the stock price, a very bad news will crash the whole index.  Some investors, including me, loves to buy stock when the market crash.

    • Example: the oil price decreases to USD 120 in a few days.  This causes the energy and commodity stock price to crash.

    • Where most people got trapped?  We will never knew what is the stock's bottom price.  Therefore some people

    • How to avoid this?

      • It is important to know the stock's real value.  It needs a bit knowledge of accounting and finance, but it is worth it.  When the stock is undervalued or on the market, then you can execute the average down strategy. 

      • Do not panic.  Panic selling when the stock price crashes deeply will only induce a big loss.  So sometimes it is better to hold the stock, not panic selling it. 

      • Buy a put option which will make profit when the stock price crash.  I'll write an article about put option later!

  3. A commodity price boom

    • This is what happened in 2006 to early 2008.  The price of commodities increases few folds.  The gold price reaches the highest point on history, passing USD 1000 per troy ounce.  One of my friend bought few hundred tons of pig irons, and he earned quite a profit when the price boom.

    • This causes the commodity stock price to boom, however other sectors will be severely hit.  E.g. the boom in oil price will increase the oil and energy company's stock by significant amount, however the transportation sector will be hit hard. 

    • Where most people got trapped?  The people who bought commodity company stock or the commodities itself when its price increases. 

    • My friend who bought the pig irons is now loosing money due to the market price drops below his average buying price.

    • How to avoid this?

      • Don't be greedy and do not follow the rally.  Just keep what you had when the rally begins, and sell it when you feel you had enough profit.

  4. Bad inflation news

    • Sometimes news on high inflation level will affect the stock price.  Most of the time the stock and index will crash following a high inflation news.  Don't worry, as long as you had a good company's stock, the price will return.

    • Where most people got trapped?  When investor sell all his crashing stock following a bad inflation news, resulting in an unnecessary loss.

    • How to avoid this?

      • Be patient.  A bad inflation news will trigger a drop in stock price.  And everyone will sell their stock, this will lead to more price drop.  This is the time to get some discounted stock!

      • Don't worry about inflation, at the end of the day inflation will also inflate the stock price anyway.

  5. Decline in profit

    • This will usually will decrease the stock price.  But beware, sometimes there is a good news on the market that is too good to be true and covering up the company's decline in profit.

    • Where most people got trapped?  Again, panic selling causes people selling their stock therefore inducing loosing money.  This condition is made severe by automatic computer investment decision maker, which will automatically sell stock when its price crosses certain threshold. 

    • How to avoid this?

      • Decline in profit is fine.  It will of course reduce the stock price, but you should still know the road is still a long way.  As long as the company is not going bankrupt, I believe it is still OK to hold its stock. 

      • Do not use automatic selling computer.  Manual is still the best way to trade.

  6. Major economic chaos

    • This is it, the awaited writing about subprime mortgage crisis.  Citi group looses 50% of its capital in just one year, and Bear Sterns is in a big-big problem with its financial situation.

    • In 2008 I was reading Warren Buffet's letter to shareholder, I realised that he had predicted this problem back in 2003.  We just too naive not listening to him.

    • When most people got trapped?  The investor who follow the rally usually trapped here.  They might bought an overpriced stock when it tumbles down.

    • How to avoid

      • Do not be greedy.

      • Do not be panic.  After the stock price crash, it might be just another chance to get discounted stock.

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