This is part of my intermittent series on price, one of the most important and commonly encountered considerations in investing and trading. For this post, I will talk about what almost everyone has in their minds now: bottom fishing.
Let us go back to the period of February to March 2020; both the Straits Times Index (STI) and S&P 500 had dropped around 20-ish percent, and you were wondering if the said indices would go down further. Assuming that you had held their respective exchange traded funds (ETFs) and wanted to add more, it would be natural to get them at the lowest price before they head upwards to recovery.
If you had bought into them on the day it went to the lowest (29 Mar 2020 for STI and 15 Mar 2020 for S&P 500, based off the graphs on Yahoo Finance), congratulations, but then my next question would be, how did you know?
Chances were, you did not. You had probably happened to initiate a buy during those days, and at the back of your mind you would have had the thought of whether it would go down further. In other words, you were lucky.
Fast forward to the present day, we see the S&P 500 is on a downward trajectory from their year-to-date (and not so much for the STI, which is holding up well) and again begs the question of how low it could go.
So, is there a way to bottom fish without the element of luck?
My answer is no.
And the reason is simple: we cannot tell the future. We can roughly guesstimate the future trends based on available indicators and information at hand, and our own observations, but we can never get a precise reading. Good news is, there are a few methods and tools that you could utilise in trying to get that price as low as possible, though not foolproof.
#1: The 10-30 Rule
I had espoused the 10-30 rule in my ebook1, which is to use 30% of the cash portion in your Bedokian Portfolio (or any cash earmarked for investment) for every 10% downturn of the financial markets. To determine the basis number to work the 10% from, I would use the STI (representing the local market) or S&P 500 (representing the U.S. market), add up the 52-week high and low numbers together, and then divide the sum by two.
Applying this in real life, using the 52-week high-low numbers from Yahoo Finance at the close of 17 June 2022, the basis numbers for the STI and S&P 500 would be around 3252.01 and 4227.75, respectively. Taking 10% off the basis will see about 2926.81 for the STI and 3804.98 for the S&P 500, thus it is a signal that the U.S. markets are ripe for entry (3674.84 as of 17 June 2022) and our local markets would have to wait a while (3098.09 as of 17 June 2022).
At first glance you may be thinking that this rule is only applicable for S&P 500 and STI ETFs (or any index ETFs). However, you can use it as an indicator for entry into individual securities, in particular counters that are in the respective indices. On the other hand, you can use the rule on individual securities itself by taking their 52-week high/low to get a basis price. Either way, additional fundamental analysis is required, e.g., to see if the drop of the share price is due to the general downtrend situation or if there are really problems with the company itself.
#2: The 52-Week High/Low
Though similar to #1, this is meant more for individual securities than indices. I had written about it here as part of the All About Price series, where I had talked about it being used as an indicator, its benefits and caveats.
#3: Reversion To The Mean
Also part of the All About Price series (here), where I had shared about using moving averages to determine the entry and exit points of securities.
As I had emphasized earlier, none of the above is a foolproof way of getting a security at its lowest point. There is no way we can predict how the markets go, and I will recommend prudence by going in piecemeal rather than committing your reserves in one-shot.
Check out the other posts in my All About Price series.
1 – The Bedokian Portfolio (2nd Edition), p131-133