Stock Market Musings – Are You an Ostrich or a Trend Follower?

It’s Friday morning after another week of stock market volatility on top of a persistent trend downwards. In such an environment the investment community tends to fall into two camps – the value investors who hold on to stocks regardless (the ostriches of the market who allegedly bury their heads in the sand in the face of danger); and the momentum traders or trend followers.

The former say that if you have purchased a sound company based on good fundamentals you should stick with it, i.e. you should ignore the noise created by the frantic crowd. The latter say that that you need to sell to avoid worse losses or to retain what unrealised profits do exist in your portfolio.

I suggested in a previous blog post that this might be a good year to sell in May and go away. That was simply because I suspect this is not a short-term market correction from excessive exuberance but a realisation that the economic prospects are in fundamental decline. Higher inflation and higher interest rates to try and bring it under control are never good for the economy.

Technology stocks listed on Nasdaq have been particularly hard hit. The Nasdaq index is down by 17% in the last month with stocks such as Tesla, Amazon, Apple, Alphabet, Facebook and Netflix down substantially. This probably reflects the fact many new investors were pulled into the market in the last couple of years when it seemed impossible to lose money on such stocks. They are now pulling out and liquidating to protect their profits.

The short-term speculators are being hit hard and this is particularly obvious in the cryptocurrency markets which are down substantially as holders panic. It’s like a run on a bank where panic feeds on mania as holders choose to take their money and run. There was a good article in the Telegraph yesterday on that subject.

Should stock market investors choose to hold and ignore the panics or bail out? It is a dangerous approach in my view to take one extreme or the other – and particularly to switch from one to the other midway during a bust. If you choose to sell out completely on the premise that one can buy stocks back at the bottom you are likely to have two difficulties. One is that it’s impossible to identify where the bottom is and secondly the bounce back can be so rapid that one can miss out and incur high trading costs. That’s apart from the psychological difficulty of going back into a stock on which you have lost money.

But following the trend downwards does protect your portfolio from a massacre and will ensure you will never go totally bust. The trend does tell you what other investors think about the attractiveness of stocks in the stock market beauty parade, i.e. tells you the views of other investors who hold the stock.

It’s best to look at individual stocks when managing a portfolio and not to move in and out in a wholesale fashion. Sometimes the valuations put on individual stocks by Mr Market can appear irrational and in that case it can be better to hold them rather than sell. That particularly applies to small cap stocks where illiquidity can magnify panics. But it’s important to manage your overall exposure to the market and not to ignore major trends.

Roger Lawson (Twitter:  )

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