During a prolonged market downturn, many good companies get beaten down in price due to market sentiments. A few months back, some good companies such Capitaland, SIA Engineering, Hyflux, ARA, etc were at low prices. I was very tempted to buy some of these companies for a short-term trade up. Even though the companies might not be undervalued per se or fit exactly into the value investing criteria of low debt, high ROE, etc, making quick bucks out of these companies seemed very tempting.
During a market crash, is it better to buy blue-chip companies for a short-term trade or wait for fundamentally strong companies to become undervalued for a long-term buy? An example of this would be, is it more prudent to employ cash to buy Capitaland for trading or use the cash to buy Vicom when the stock becomes undervalued? There’s no perfect answer as you wouldn’t know if Vicom will come down to your predetermined price or if Capitaland will actually rise in price if you buy it. However, during a market downturn, to generate some returns, one can do trading for the short-term. To increase the “margin of safety”, doing trading only during a market crash or prolonged downturn can increase the chances of capital appreciation tremendously.
Trading can be done by looking at charts. I’m really new to trading but I use indicators such as the 2 period EMA and 5 period EMA crossover, together with candlestick patterns, volume, stochastics and MACD. I also look at valuation ratios and try to trade when the P/B and P/E ratios are near the lows seen in the previous crisis, i.e. the sub-prime crisis in 2008-2009. To be prudent, it’s wise to keep the trading to less than 5% of the stock portfolio. By doing so, one can take advantage of the low prices of the blue-chip companies and at the same time, keep any losses to a minimum. Also, by employing little cash for trading during a market crash, one can keep some cash when Mr. Market becomes more maniac-depressant and throws up some good companies at bad prices.
As a case study, Capitaland was trading at around $2.30 in early January 2012. Now, it’s at $2.89. This is approximately a 26% gain. In hindsight, this is a perfect trade. However, at the point in time, will buying Capitaland seem to be a good deal? No one can say for sure but by limiting your trade to less than 5% of your portfolio, you can at least keep your emotions in check should things go wrong and at the same time, generate decent returns.