The Panic Trade
October 28, 1929.
No internet, no 24-hour news channels. Telephones were rare, news broke over a thin strip of paper with holes in it that had to be deciphered.
Sadly, it was a Monday. People had been stewing for the entire weekend, wondering what to do, no real information coming in.
Some had been young teenagers, barely in high school when their shell-shocked fathers had returned from the trenches of the first World War, relegated to the silence that bespeaks untold horrors. In general – interpersonal communications was not yet the fashion. Everything was sublimated, at best to metaphors and euphemisms.
And then, precisely at 9:30 am, the bell rang on the floor of the New York Stock Exchange.
But nobody heard it.
Shouts of “sell!” and many less of “buy!” drowned out the sign as the Dow began its 13% drop …
… in a single day…
… and shares devalued to below the price of the paper slips that represented them. The entire country,[i] ignoring warning signs, had been riding a gravy train of excess throughout the post-war years – the “roaring 20s” – creating a bubble of greed and speculation so large that its explosion was heard around the world (indeed, the London Stock Exchange had crashed the week before).
And an inordinate amount of the fuel was supplied by pure panic.
At this point, two questions arise: 1. how do we avoid panic trading; and 2. how can we benefit from it while everyone else is busy trampeding with the herd.
Dealing with Fear
Our first question is relatively easy to answer.
Let’s take a moment to look at the term ‘panic’. The dictionary defines it as a “sudden sensation of fear which is so strong as to dominate or prevent reason and logical thinking, replacing it with overwhelming feelings of anxiety and frantic agitation consistent with an animalistic fight-or-flight reaction.”[ii]
Because panic is most often associated with fear and the unknown, we need to take steps to prevent these two instincts from being an issue. The unknown becomes less so with every step we take to do our homework: never invest in an asset you know absolutely nothing about. Learn its fundamentals. Read every scrap of information you can find about it, whether that be news – past and present, background information and historical charts, to see how the former two translate into market movement. Another aspect of the unknown and coming prepared is countered by preparing a well thought out investment strategy. Once you have studied your asset, decide upon an entry point and what market orders you intend to place. With a plan in hand, you leave less to chance, less to the unknown.
Fear may be a bit trickier, but once we know what we fear, it’s relatively easy to neutralize it. Fear of loss is a financial thing. Simply minimize your risk by investing sums that are small enough to be lost with indifference and making sure that your margin level remains well above what it needs to be. Also, don’t forget those stop-loss orders. Err to the side of caution and don’t ever move them based on a whim.
Fear of failure is battled less by concrete steps than by regulated thinking. Repeat yourself so that it becomes a mantra: “Loss does not constitute failure! An unsuccessful strategy is not my fault but the market’s!” A position that fails to produce profit is not right or wrong; it is merely an example of momentary mismatch between the pattern you discerned and the behavior of the market at that specific moment. Examine both your strategy and the market. Try to discern where the two departed ways. Integrate your conclusion into you strategy-building technique.
In general, fear of failure can usually be ascribed to pure and simple ego – that same ego that has you holding on to a losing position even when you know you should have closed it. But that would be an admission of failure! No! it would mean you’re smarter than your emotions. You can put a distance between your emotions and your deeds. Again: small sums and deriving a learning experience from each loss is what makes that loss a success.
How to Behave in a Panic Market
Now that we have tamed the beast, it’s time to harness it and put it to work.
To begin with, we need to ask ourselves how does panic reveal itself in the market?
Panicking markets are usually characterized by high-volume selling following an unexpected event that causes an asset to be re-evaluated by its investors. Following an initial rapid decline in value, the price will vacillate as buyers and sellers struggle to create a new trend, then continue dropping until the market defines a new long-term channel.
As soon as the pattern is identified, an astute investor will do one of two things – ride the new trend or simply wait for the market to “bottom out” (characteristically waiting for a 40 &/or 50 day SMA to be broken and then retested) and then initiate long positions to utilize any upcoming correction or close the position, in the case of trend riding. This is especially useful if one believes that the initial instigator was speculation or an uncharacteristic event.
[i] Well, not the entire country – just those of its classes that didn’t have to actually work for a living. The others had already been feeling the brunt of a non-productive economy for years, whether they were impoverished farmers or unemployed factory workers.