The natural reaction to global epidemics viewed through the eyes of the world media is fear. This can and will cause knee-jerk reactions when it comes to managing your finances and investment portfolio that will be detrimental to your long-term financial success.
During these times, it is imperative to understand how to manage and get the best out of your hard-earned money and this all boils down to financial literacy.
Since the coronavirus came to our attention, it first appeared as though it was restricted to China but such is the nature of a virus, it soon crossed boundaries with an increasing number of cases being reported around the world and as a result, panic spread.
It was only a matter of time before this was somehow reflected in the financial markets which was clear to see last week with the S&P 500 dropping over 12%, one of the biggest declines in market history.
Looking at similar past events, the leading question is what can we learn from these historic global health threats when it comes to managing our finances?
We have broken this down into the following 4 points:
1. Good investors remain calm
This is put best by the great man himself, Warren Buffett, when he said:
“Be fearful when others are greedy and greedy when others are fearful.”
Remaining calm when the world seems to be melting into a global state of panic is an essential trait to a good investor and, as already mentioned, this boils down to financial literacy and being able to detach from what is being said in the news as well as translating the epidemic into how best to manage your finances. The best way for private investors to do this is by learning how to read charts, a simple skill to learn with a flashy name called ‘technical analysis’. Looking at charts just means to look at past price action to determine patterns that are likely to and will repeat in the future. These patterns are called ‘trends’ and looking at charts and using technical analysis is a proven technique used by some of the best investors and traders going back way before the tech age. Investing and profiting from trends is a technique called ‘trend-following’.
2. Price finds support
A lack of financial literacy means being susceptible to how the news translates events in the financial markets. The 15% drop in price on the S&P 500 occurred in a very short space of time and which will appear frightening at first glance, this does not mean we are entering a complete meltdown just as yet. In fact, far from it which we will elaborate on in point 3.
Declines, also known as pullbacks and corrections are part and parcel of the natural movement or price. They are expected and embraced by seasoned investors and traders who have a long-term view of the markets. They are unremarkable in their pace and are simple periods where good investors apply patience as these periods offer investment opportunities.
How is that? Well, this is where technical analysis comes in and where looking at charts and past price behaviour can show key levels where price is likely to decline to, stop declining, correct and move back to the upside. These levels in financial terms are called support and resistance levels. See the chart below.
The main difference between a regular decline and the decline of last week based on the coronavirus is the pace at which it moved and the depth it moved to before finding support and this is where panic sets in. This does not mean to say that price won’t find support, in fact, history shows the opposite and price does have a habit of finding support and moving back to the upside.
A real-life way of looking at this is having a 5-year plan and missing a bus along the way. This is likely to have a small impact but often nothing that cannot be sorted out by remaining calm and a phone call.
It is the same with good long-term investing, these periods will have an impact but nothing that cannot be rectified by remaining calm and continuing with your 5-year plan particularly if you have followed good risk-management principles.
A common method to determine key support and resistance levels is the use of Fibonacci numbers, which you will have heard is used to measure distances in the universe as well as in nature which is evident in the number of petals on a plant.
In the image below we can see how the 50% Fibonacci level was used as support during the pullback from September 2018 to December 2018 and again during the recent sharp pullback of last week.
Could this be history repeating itself? It certainly has a habit of doing so but we first need to apply patience and let price dictate a recovery before taking advantage of some of the investment opportunities that will be presented to us during the recovery phase of the market.
3. A strong bull market emerges
What we have learnt from health epidemics from the past is that although it usually causes rapid declines in the markets, negatively affecting investments, a strong bullish trend usually follows rewarding the savvy financially literate investor.
Let us take a look at the 3 most recent cases of virus outbreaks.
- MERS affected the markets from September 2012 to November 2012 and was followed by a 38% rise.
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Ebola affected the markets from December 2013 to February 2014 and was followed by a 22% rise.
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The Zika virus affected the markets from November 2015 to February 2016 and was followed by an 88% rise.
4. Move through the natural cycles of the market
Smart investing is all about establishing high-probability environments and so even though there are no guarantees, these repeating patterns should not be taken for granted. In fact, the chances of these patterns repeating are higher, but again this is where patience comes in and where we let price dictate a recovery first before making any investment decisions.
History suggests that those who are well-prepared are well-rewarded too.
The final point to note is that the stock market is just one market. Here at Sublime Trading, in addition to the stock market, we focus on the commodities and currency markets too and the reason for this is that when trends dry up in one market they often appear or continue in other markets.
Smart investors move to where the money is with little hesitation.
Palladium is a top-performing commodity that has been in our portfolio since last year and there is no evidence to show that this has been affected by the virus.
We can also add gold to the list which investors often use as a safe haven when moving money away from the stock market. Gold has been showing strong signs of bullishness since last year and there is also no concrete evidence that this is coming to an end just as yet.
There are also bearish trends appearing on the AUD currencies. As a side note, after being inundated with the fires, there is very little correlation being made in the news on how the fires Down Under are having an impact on the AUD currency. Just goes to show how the news like to cherry-pick what we are told.
And finally, if the market does continue to decline, then savvy investors will know how to ‘short’ the market like they would have done in 2000 and 2008 when so many would have lost money and would have waited years for their investments to recover. This will require an understanding of market conditions.
So in summary,
- Stay calm at all times.
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Using technical analysis, let price dictate the bottom of the decline and a correction back to the upside.
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Let price dictate the emergence of the next bull phase.
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Keep an eye on trends in other markets as well as a potential to short the stock market.
Keep it simple, keep it Sublime!