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Why A Sell Off Can Be Positive

By Louis H-P on October 27, 2020

Reading Time: 3 minutes

A sell off is part and parcel of investing in the stock market. The first one will be a shock, the second one difficult. The third you will stop focusing on your stock portfolio‘s loss of value to seek out opportunities. Yet what are the causes and how can they be anticipated? 

Key Takeaways

What is a sell off

Famous sell offs to be aware of

Why you should see them as an opportunity


What are the typical causes of a sell off?

They can happen for any number of individual reasons or combination of. The most likely sell off is a systematic risk event, which causes everyone to sell their equities and rush into US treasuries, gold or cash. This is panic led selling and best not to take part in it.

Typically when there is a market rally over a short period of time, you will see profit-taking across individual shares. This can morph into a sell off as happened with Black Monday. Portfolio managers report on their portfolio performance quarterly. They will often reduce positions which have done well at quarter end. They can then write to their client telling them ‘what a good job they have done!’

Remember, the stock market is a leading indicator. It is pricing in today the expectation of tomorrow’s financial results. Therefore a negative piece of political, economic or general business news, changes the stock markets expectation of future returns. This will require re-pricing, which in turn can cause a sell off.

Biggest sell offs and why they happened

Although the 1929 stock market crash is probably the most famous sell off of them all, it took place over several days and months. As a result, it is more of a crash than a sell off. Stock market history has plenty of examples of sell offs which can teach us something.

Black Monday was a sudden and global sell off in 1987, which started in the USA and soon spread to all parts of the world. There was no one specific reason or clear combination of reasons. Investors just started to panic and sell. This led to more selling and before anyone realised it, world stock markets has lost 20-40%!

More recently the March 2020 Coronavirus-caused sell off was brutal both in the speed at which it sold off, and the manner in which it snapped back. Such sell offs are a fantastic opportunity to buy at a substantial discount. A contrarian investor may pounce on undervalued stocks caught up in the selling.

S&P500 March 2020 sell off
S&P500 February – May 2020

Computer says no

The 2010 Flash crash was a USA specific event which caused a great deal of confusion, but fortunately for many investors did not spread. Over a period of a couple of hours, US stock markets collapsed and then rebounded very quickly. Even the most volatile stocks had not seen this kind of volatility.  It was one of the largest intraday moves ever seen, it was not caused by mass panic selling.

Some sell offs are still unexplained.

Although there has been an official explanation, apparently a Brit in his parents bedroom caused it, it is more likely that something new within trading caused it. As markets evolve with newer, more complex financial products, the old technological infrastructure can struggle to keep up and just ‘falls over’.

The unexpected is something investors should be prepared for. Some events will never be explained. Ensure you make a mental note. This way you can factor in some margin of safety within your portfolio, to ensure you do not lose out to downside risk.

It is an opportunity to buy

Occasionally you will welcome a short sharp drop in share prices. When markets rise too quickly too soon, then it becomes difficult justifying buying in. When markets head south, they are ‘blowing off the froth’ and providing you with the opportunity to buy in.

For those who are already invested, maybe who have started building a small position, this will give you the opportunity of doubling down. Since quantitive easing became ‘de rigueur’ in Western stock markets, a buy the dip mentality has also become prevalent. This means a sudden drop in stock markers has become welcomed, especially when the New York Federal Reserve responds with yet more stimulus.

Conclusion

It is impossible to predict when a sell off will occur, but you can anticipate one when there is so much momentum trading going on. Reducing successful positions, because other investors will do the same during a sell off, before it occurs means you are banking profit near the top.

This will also give you cash to use to buy sold off positions. For the more adventurous, taking positions in gold may benefit as it tends to increase in period of volatility.

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Louis H-P

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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Louis H-P

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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