In an extreme bear market, investor confidence is positively subterranean. All faith in the market has gone and the human instinct is to bail out. Rational thought is abandoned as panic selling sets in.
With the same frenzy as they bought a stock when it had tripled in value; the same investor, finding themselves in a bear market, is now desperate to offload seemingly at any price. Perhaps for some investors, they are forced to sell but for many, as panic sets in, the only thing they are doing is crystallising a loss. Probably not their finest moment – but they are by no means alone.
Mass bail out
An indiscriminate market sell-off is when the herd instinct kicks in. With so many investors bailing out, it takes nerve to go against the stampede and stand firm. “If everyone is selling; shouldn’t I be doing the same?”
Well no, not necessarily. It may be that a stock market correction or crash has exposed a stock as an absolute basket case. If that is a case, then perhaps you should cut your losses. But in many instances when a whole sector or asset class has taken a caning, there are many good companies that are caught up in the hysteria. As their share price weakens so more investors see the downward momentum and join the selling spree.
Following the herd
The fact that the company’s fundamentals remain strong, that it has a dominant position in its market, that is debt free, cash generative with a healthy forward order book, may count for nought if the herd is piling out of a sector.
The bears are running wild but those who take a more measured approach and look at the fundamentals of a company rather than just the share price, may decide to hold and not sell.
They may decide to add to their weighting in the stock as they see the valuation dip further and present an ideal buying opportunity. For others who have no previous exposure to this stock, it may prove a good entry point.
Blood on the streets
As one fund manager once put – ‘the best time to buy is when there is blood on the streets.’ The market is reeling, the headlines are all gloom and most are looking for the exit signs – that maybe is when you find the diamonds in the dust.
But we are not talking about wild punts here, it is a case of evaluating market sentiment – why it is where it is – and identifying where value might lie.
In an ideal world we would all be able to identify the height of a market, sell at the peak and then start buying back in when prices have hit rock bottom. It is never that simple, but it is possible to have a clearer direction of where markets are headed and base investment decisions on useful analysis rather than speculation and opinion.
The world-wide web may be a wonderful thing, but it can also be responsible for information overload. After reading a selection of investment manager reviews and broker recommendations you will no doubt find yourself weighing up contradictory ‘evidence’.
Too much noise
For instance, there are those adamant that an equity rally has much further to run; while others urge a sharp exit before an imminent market correction. There are mixed messages - "valuations are not excessive" “valuations are stretched” "the rally is 'unloved' (hinting optimism is not overly bullish)"; “the bad news has/hasn’t been priced in”; "Asian stocks are the only game in town"; “Asian markets starting to look very frothy.”
None of us has a crystal ball – which is why it usually pays to get away from all the noise in the media and try and base investment decisions more systematically, using a disciplined market indicator approach.
The Bear Power indicator
The Bears Power Indicator is a useful tool to use. It enables you to identify if the sellers in the market are weaker than buyers. If that is the case, then you can look for long positions to ultimately take advantage of a trend change. In simple terms the Bears Power is the difference between the close price and the exponential moving average.
The Bear Power indictor provides trading signals. Essentially, If the moving average is rising and the Bears Power index is below zero, but growing, that it is a clear ‘buy signal.
This indicator aims to identify if a bearish trend will continue or if the price has reached a point where it might reverse.
The Bears Power Indicator uses the Low of the price and a Exponential Moving Average (EMA). The EMA represents the middle ground between sellers and buyers for a certain price period.
The Bears Power is the difference between the close price and the exponential moving average. The basic formula for calculating the Bears Power is:
Bears = Low - EMA
By taking the emotion out of your trading and using maths rather than gut instinct – you may be in a position to make money when the bears run wild.