Tuesday, June 12, 2007

Market Corrections

I was reading Canadian Dream's blog this morning. His post and the comments by others got me thinking.

The TSX market has had a few down days and that will make some people take notice. If your at all interested in the stock market its hard to avoid this type of news. The media is "part of the system" that drives the markets.

Some people will take action. Some people will just get nervous. Some will actually sell shares. Some will see it as a buying opportunity and buy more shares. At this point we can't know whether the market will continue to drop lower or whether it will quickly resumes its upward climb.

The most normal human reaction is to be a little nervous when one looks at the chart. The TSX has done very well lately and a larger correction may be over due. Running at the first sign of danger is a trait that has saved many humans over the ages. It is at times like this that one learns whether they are cut out to believe in the "buy and hold" investment philosophy.

The best buying opportunities lie somewhere ahead...when the next large correction occurs. And it will occur...we just never know when. It may be very sudden and almost overnight or it may be a slow dragged out process. We can't know when it will happen and what triggers it could be something that never happened before.

It is very important to understand that market corrections are more of a risk to those who have a lot of money invested in a few stocks.

The TSX Comp Index will always come back. You can bet the farm on this. Yes, for larger corrections, it may take years, but it will come back. The 2000 to 2006 was the last good example. It took about 6 years for the correction and subsequent recovery. I wouldn't be surprised to find out that most private investors sold at least part of their holding during this bear market period.

In sharp contrast, some individual stocks never recover. One of the nice things about the index is that it benefits from "survivorship bias". When the price of a share drops below a minimum threshold value the stock is dropped from the index. This important fact can mislead people into thinking that any and all stocks perform like the index.

If your like me... you missed the last great buying opportunity. In hindsight, if I had borrowed all I could and invested it in the market index at intervals throughout the 6 year correction I would be a lot richer today. My excuse today is ignorance at that time. If I fail to catch the next great buying opportunity my only excuse may be a lack of courage and conviction.

2 comments:

FourPillars said...

The only problem is how do you know when there are 'good' buying opportunities? When the market has gone down 5%? 15%? 25%?

One other thing - If I'm not mistaken it took the TSX six years to get back up to the peak value (of 2000) in 2006. This shouldn't imply that a typical investor was underwater from 2000 to 2006. That would only be the case if they happened to invest all their money on that peak day in 2000.

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