A week ago this past Thursday the stock market as represented by the Dow Jones Industrial Average opened at 10,868 and by 2:20 p.m., on fears that the sovereign debt crisis gripping Greece would first spread to the rest of the European Union and then across the ocean to the United States, had fallen by 420 points. However, over the following SIX minutes the Dow would fall another 600 points in what many have subsequently described as a “Flash Crash” only to then rebound by more than 700 points over the following 40 minutes before closing the day down approximately 348 points. Many blame the sudden drop on a “fat fingered” trader who had intended to sell one million shares of a particular security and pushed a “b” rather than an “m” and ended up attempting to sell a billion rather than the million which, in turn, triggered computer trading programs which sent the markets lower in a cascading fashion. Others blame the sudden drop on a lack of cooperation and consistent procedures between the exchanges. Regardless of the cause of the decline, in hindsight there are several lessons investors can learn as a result of it. They are as follows.
MARKET ORDERS IN AN ILLIQUID MARKET CAN BE EXECUTED AT A PRICE MUCH LOWER THAN WHAT MAY HAVE BEEN INTENDED. For instance, during the timeframe noted above Procter & Gamble (PG) plunged from around $60 per share to a little over $39 per share as bids (what one is willing to pay to, in this case by P&G) literally dried up only to then recovery back to $60 per share minutes later. If you had placed a market order to sell $100 shares of P&G and had the bad luck of placing it at precisely the wrong time you could have sold at $39’ish per share only to see the stock rebound back to $60 in a few short minutes. The cost to you would have been $2,000. Lesson learned.
GOOD-TIL-CANCELED STOP/LOSS ORDERS CAN BE HAZARDOUS TO YOUR FINANCIAL WEALTH. Continuing on with Procter & Gamble, let us assume that you were concerned that the overall stock market as well as P&G might go down and in order to protect your investment, you placed a stop/loss order twenty-five percent below the current market price of $60 or at $45/share. By definition, a stop/loss order is an order to sell a security at a certain price, in this case $45/share. Furthermore, a stop/loss order becomes a market order once the security reaches that price and is then sold at the market price. Unfortunately, P&G went through this price bottoming at $39 or so per share. You therefore, would have sold P&G for $39’ish per share, once again, only to see it rebound more than $20 per share and close at $60.75 per share. Lesson learned.
IN ADDITION TO OTHER CRITERIA, ALLOCATE YOUR ASSETS ACCORDING TO YOUR OBJECTIVES AND TOLERANCE TO RISK AND IGNORE THE SHORT-TERM SWINGS IN THE MARKET. The only individual who usually profits from impetuously taking action is your broker and not you. If you were staring at your computer witnessing the plunging market and decided to take some action and told your broker to “sell everything” you would have lost about 5% in relative value by the end of that day. Another painful lesson learned.
EVERYTHING IN MODERATION. Continuing on with the above example, even if you did want to sell some holdings, do just that, sell SOME holdings. Do not panic. Sell down to your comfort level, keeping in mind your objectives.
EVENTS AND CHANGES IN THE VALUE OF YOUR PORTFOLIO DICTATE PORTFOLIO ADJUSTMENTS, NOT THE CALENDAR. So often, Investment Advisors recommend reviewing your portfolio “at the end of every quarter” or “once a year.” Hogwash. Your investment portfolio is a “motion picture” and not a “static photograph.” It evolves. It changes. It progresses and regresses. Keep in tune with these changes, being careful not to over manage and be aware of market conditions which may allow you to improve your portfolio or, on the other hand, take some profits. Last Thursday could have been a time when you might have upgraded your portfolio.
THE BOTTOM LINE – One week later after having plunged below 9,800 the Dow is flirting with 10,900, having recovered all of the ground it lost and then some. We believe that the U.S. stock market will become more attractive to investors as they experience turmoil in the foreign equity as well as fixed income markets.