VirginiaBob
Member
Many have lost some serious dough with this recent correction. If you were out of the market already, you lucked out. If you were in the market during the correction, you took your bruises. But everything that happened this past week is finished, so let's look towards the future. There are 3 ways one can deal with this recent stock market correction. You can:
1. Get in the market and wait it out, since it is inevitable that the market will eventually reach a new high anyways, more likely sooner than later. Pros - Will see a gain on your money. Cons - At best you are only matching the returns of the indices over the same period, which is not necessarily a bad thing. I'd recommend this approach for most people.
2. Get out of the market, since the correction might not be over. Pros - possibility of buying at new lows. Cons - when exactly do those new lows happen, or have they already happened, in which you will be caught in a double whammy (already lost 5%, and then missed a few % of the recovery). Large whipsaw risk as well by getting in at the first sign of strength, which could be a huge mistake as shown in my analysis of the 3rd option below. This is probably the riskiest approach, but this is what many on this board are discussing of doing (get back in at a sign of market strength). I'd recommend most people don't use this approach.
3. For approach 3, first let's take a look at the previous 3 most significant corrections that the market has endured.
Take a look at these numbers. The previous 3 most significant corrections did not happen all at once. The happened in 3 phases. These are easier to see graphically, but I'm not that internet savvy to do so in a post.
May-June '06 Correction (total 7.7% loss):
Phase 1 - S&P Dropped from 1325 to 1256, 5.2% drop over 2 weeks
Phase 2 - S&P Went up from 1256 to 1288, 2.5% gain, over a week
Phase 3 - S&P Dropped from 1288 to 1223, 5.0% drop over 2 weeks
March-April '05 Correction (total 7.2% loss):
Phase 1 - S&P Dropped from 1225 to 1171, 4.4% drop over 2 weeks
Phase 2 - S&P Went up from 1171 to 1191, 1.7% gain, over 2 weeks
Phase 3 - S&P Dropped from 1191 to 1137, 4.5% drop over 2 weeks
June-Aug '04 Correction (total 6.8% loss):
Phase 1 - S&P Dropped from 1140 to 1086, 4.7% drop over 3 weeks
Phase 2 - S&P Went up from 1086 to 1106, 1.8% gain, over a week
Phase 3 - S&P Dropped from 1106 to 1063, 3.9% drop over a week
So it looks like we are getting an intial drop, followed by a a correction that recovers 38-48% of the initial drop, then a final drop which is about equal to the first drop.
So currently over the last 2 weeks we have seen a 4.9% drop in the S&P 500. So assuming the same scenario above happens, we are going to recover approximately 2%, and then drop another 5% or so.
That said, we don't really know if we are going to get a phase 1,2,3 scenario like we did the last 3 times. Myself, I am going to stay all in, hope for a Phase 2 scenario, then cut back to 50% in stocks after about 1.5-2% of gains, and sell my well down a Phase 3 scenario until it goes down 5%. If the phase 2 scenario never happens, at the worst case, I'll be doing option 1 (see above) and simply remain all iin, and matching the stock market returns, which is not all that bad. If when I cut back to 50% stocks towards the end of Phase 2, and the market keeps going up, I'll potentially miss some gains and will have to be timely in realizing when we are back in a bull market. If this happens, in my case it works out, because I missed most of Phase 1 as well.
1. Get in the market and wait it out, since it is inevitable that the market will eventually reach a new high anyways, more likely sooner than later. Pros - Will see a gain on your money. Cons - At best you are only matching the returns of the indices over the same period, which is not necessarily a bad thing. I'd recommend this approach for most people.
2. Get out of the market, since the correction might not be over. Pros - possibility of buying at new lows. Cons - when exactly do those new lows happen, or have they already happened, in which you will be caught in a double whammy (already lost 5%, and then missed a few % of the recovery). Large whipsaw risk as well by getting in at the first sign of strength, which could be a huge mistake as shown in my analysis of the 3rd option below. This is probably the riskiest approach, but this is what many on this board are discussing of doing (get back in at a sign of market strength). I'd recommend most people don't use this approach.
3. For approach 3, first let's take a look at the previous 3 most significant corrections that the market has endured.
Take a look at these numbers. The previous 3 most significant corrections did not happen all at once. The happened in 3 phases. These are easier to see graphically, but I'm not that internet savvy to do so in a post.
May-June '06 Correction (total 7.7% loss):
Phase 1 - S&P Dropped from 1325 to 1256, 5.2% drop over 2 weeks
Phase 2 - S&P Went up from 1256 to 1288, 2.5% gain, over a week
Phase 3 - S&P Dropped from 1288 to 1223, 5.0% drop over 2 weeks
March-April '05 Correction (total 7.2% loss):
Phase 1 - S&P Dropped from 1225 to 1171, 4.4% drop over 2 weeks
Phase 2 - S&P Went up from 1171 to 1191, 1.7% gain, over 2 weeks
Phase 3 - S&P Dropped from 1191 to 1137, 4.5% drop over 2 weeks
June-Aug '04 Correction (total 6.8% loss):
Phase 1 - S&P Dropped from 1140 to 1086, 4.7% drop over 3 weeks
Phase 2 - S&P Went up from 1086 to 1106, 1.8% gain, over a week
Phase 3 - S&P Dropped from 1106 to 1063, 3.9% drop over a week
So it looks like we are getting an intial drop, followed by a a correction that recovers 38-48% of the initial drop, then a final drop which is about equal to the first drop.
So currently over the last 2 weeks we have seen a 4.9% drop in the S&P 500. So assuming the same scenario above happens, we are going to recover approximately 2%, and then drop another 5% or so.
That said, we don't really know if we are going to get a phase 1,2,3 scenario like we did the last 3 times. Myself, I am going to stay all in, hope for a Phase 2 scenario, then cut back to 50% in stocks after about 1.5-2% of gains, and sell my well down a Phase 3 scenario until it goes down 5%. If the phase 2 scenario never happens, at the worst case, I'll be doing option 1 (see above) and simply remain all iin, and matching the stock market returns, which is not all that bad. If when I cut back to 50% stocks towards the end of Phase 2, and the market keeps going up, I'll potentially miss some gains and will have to be timely in realizing when we are back in a bull market. If this happens, in my case it works out, because I missed most of Phase 1 as well.
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