A painful lesson learned from a 20 million yuan loss: Regarding bottom-fishing in US stocks, you only need to remember these "three dos and three don'ts".

Author: SOL I Can't Understand

After losing 20 million yuan, I finally understood the probability of successfully timing the market top in A-shares and bottom-fishing in US stocks. When investing in A-shares, the most important thing is to time the market top; when investing in US stocks, the most important thing is to buy at the bottom.

Escaping the top in the A-share market, especially the major top, is both the easiest and the most difficult. It's easy because A-share market tops are typically characterized by a lot of noise and speculation; in hindsight, it's as if the words "major top" are written all over the candlestick chart.

It is difficult because in the A-share market, you can only make money by going long, and the stock market will rise in the long run. Trying to sell at the top is equivalent to locking in profits, which does not make money in itself, and human nature is greedy.

In comparison, the most important thing for US stocks is to buy on dips. Looking at the market over the past 20 years, buying on dips is the most important investment rule.

In other words, if you've already invested money, you can simply hold onto it. The key question is when to buy the dip with new money? And when investing in US stocks, buying the dip is both the easiest and the most difficult part.

The reason it's considered easy is that bottom-fishing in US stocks boils down to "buy small dips, buy big dips, and don't buy if there's no dip."

Since 1776, all those who bet on the failure of America have ultimately ended up suffering their own crushing defeat.

The reason it is considered the most difficult is that most people have transitioned from the A-share market where they "buy the dip but end up buying at the halfway point of the decline," and they have a "bottom-fishing PDST syndrome." They always want to buy even lower to give themselves some safety protection, but as a result, they are always afraid to buy the dip when the market is falling, and then they chase the market when it rebounds.

Therefore, when a buying opportunity arises in the US stock market, everyone must understand two things:

1. Under normal circumstances, how much will the US stock market fall in a single correction?

2. What if a black swan event occurs, and the market continues to fall?

1. How deep is the correction in US stocks? First, we need to define what constitutes a "correction".

Adjustments are generally categorized into three levels: daily, weekly, and monthly. A decline must meet one of two conditions: magnitude and duration (each person's definition may differ; this article only represents my standard).

• Daily chart: A drop of more than 5% from the highest point, or a period of more than two weeks (referring to the time span from the highest to the lowest point).
• Weekly chart: A drop of more than 10% from the highest point, or a period of more than 4 weeks;
• Monthly chart: A drop of more than 15% from the highest point, or a period of more than 4 months.

Meeting either of the two conditions is sufficient; some adjustments are minor but prolonged, while others are the opposite. Once the definition is clear, bottom-fishing essentially has two objectives:

• Objective 1: Buy the position you want.
• Objective 2: Buy as cheaply as possible.

The market always becomes clearer in retrospect. When things seem confusing at the time, and a correction is underway, we can only be certain of two things: how much has the market fallen from its previous high, and how many days has it been falling?

It may continue to fall, consolidate, or rise again.

Therefore, there is a contradiction between these two goals. Buying too quickly may result in achieving goal one, but at a relatively high price.

However, if you're only focused on buying cheap, you might end up not being able to buy it before the price goes up.

This requires us to have some probabilistic understanding of the magnitude of historical corrections in the US stock market in order to set a reasonable target.

Historical 30%+ drawdowns in US stocks and their causes

Taking the S&P 500 index as an example, in the 20 years from 2004 to the present, there have only been 7 monthly-level corrections. The reasons are as follows:

• January-October 2022: The most aggressive interest rate hike cycle in 40 years
• February-March 2020: Global Public Health Events
• September-December 2018: Trade War Coupled with Interest Rate Hikes
• July 2015 - February 2016: Central economic recession coupled with expectations of interest rate hikes
• April-September 2011: The European debt crisis deepened.
• April-June 2010: The European Debt Crisis and the Goldman Sachs Fraud Scandal
• October 2007 - March 2009: The Subprime Crisis

Therefore, monthly-level corrections in the US stock market are very rare, averaging once every three years, and each correction is due to macroeconomic fundamentals. In fact, there was no such correction in the 44 months from September 2011 to July 2015, making it a solid long-term bull market.

There are more weekly-level corrections, occurring 2-3 times a year. They don't require fundamental reasons; as long as the price has risen too much, a correction is likely.

Therefore, the first step in bottom-fishing is to determine whether this is a weekly or monthly correction.

However, stock market trends are influenced by various new information and are difficult to predict accurately. The Federal Reserve is not your private property, and negative and positive news will not arrive as you plan—fortunately, you can still decide your own goals.

You need to think about this question: Imagine this is haggling with a vendor. If you could only choose one of the two goals, "to buy" and "to buy cheap," what would you choose?

If it's the former, then you should assume the adjustment is at the weekly level and plan accordingly. This way, even if a monthly level adjustment actually occurs, you can still achieve your first goal. Similarly, if your goal is to "buy cheap," then you should prepare a bottom-fishing plan for industries during a monthly level adjustment.

However, under normal circumstances, I suggest that everyone should make "buying" their primary goal, especially when you have spare cash. Firstly, because monthly-level corrections only occur once every three years, and the probability is indeed not high. Secondly, if you have spare cash but cannot buy US stocks, you are likely to buy other high-risk products.

With a goal in mind, the plan becomes much simpler.

2. Time and Location Planning: The First Question for Buying the Dip in US Stocks – When to Start?

Taking the weekly correction as an example, if a new high is not reached within two weeks, a daily correction is already underway, and a plan to buy at the bottom during this cyclical correction should be prepared.

The key to bottom-fishing in US stocks is two words: phased buying.

There are two types of phased buying plans: one is time-based, where you buy at regular intervals; the other is position-based, where you buy when the price drops to a certain level. Based on the trends of the past 20 years, the average time from the high to the low of a weekly correction (excluding monthly corrections) is 10 weeks. Therefore, time-based buying can be divided into three phases, buying the dip every three weeks from the high point onwards, with a longer interval between the first and second purchases.

The strategy can be implemented in batches, or even in three batches. Buy one batch when the price drops by 3% from the high point. If the price drops by a maximum of 10%, the entire bottom-fishing plan can be realized.

The probability of these two plans being completed is different. The time plan can generally be completed, unless it is just a daily-level adjustment and a new high is reached soon. In that case, it is not a pity, as at least you have seized an opportunity to increase your position during a daily-level adjustment.

However, the phased approach may not be completed. Many weekly corrections in US stocks have been prolonged but have not reached 10%.

If the primary goal of a weekly-level correction is to "complete the bottom-fishing", then the priority should be to "buy in batches over time" . Even if the decline has not yet reached its target, the plan to buy in batches should be implemented as soon as the correction period is over.

Looking at bottom-fishing plans targeting monthly-level corrections, the average time to reach the bottom is 6.5 months, but the time varies greatly. Therefore, one should adopt the idea that "it is highly unlikely that you will be able to buy everything at once" and only buy as much as you can.

The position size does not need to be evenly distributed; instead, the larger portion should be allocated to the beginning and the smaller portion to the end, with the three batches representing 1/2, 1/3, and 1/6 of the total plan, respectively.

The timeline can be divided into batches: the first month, the third month, and the sixth month. The positional plan can be divided into batches: a drop of 3%, a drop of 8%, and a drop of 15%. Often, you aim for a "monthly level" adjustment, but end up actually completing a weekly level adjustment bottom-fishing plan, but the volume is insufficient. Therefore, I still recommend focusing on the weekly adjustment plan as much as possible from the beginning.

Buying US stocks at the bottom can be summarized as three dos and three don'ts:

1. Make phased plans and avoid random decisions and impulsive trading during trading hours;

2. Focus on "buying enough" as the primary goal, and "buying cheap" as a secondary goal;

3. The strategy of bottom-fishing in US stocks is primarily based on "time-based batches" and secondarily on "location-based batches." This is a very mechanical plan, and the long-term upward trend and relatively low volatility of US stocks are the prerequisites for this bottom-fishing plan.

However, the stock market is ultimately a battleground of human nature, and the economy itself is unpredictable; black swan events can happen at any time and are inevitable.

What should we do if the adjustment time or depth exceeds the plan? What should we do if a black swan event occurs?

3. Black Swan Events

The above adjustments are divided into monthly and weekly levels. The advantage is that the standards are relatively clear. However, even among monthly level adjustments, there are still significant differences. In 2008 and 2020, the actual events were economic crises rather than stock market adjustments.

Therefore, market adjustments can also be divided into three categories based on their causes:

1. A natural correction due to excessive cumulative gains, but the macroeconomic fundamentals are generally positive – this is the case for most daily and weekly level corrections.

2. Adjustments caused by overvaluation coupled with economic recession or a bearish shift in interest rate policy – ​​these are the type of adjustments seen in a few weekly charts and most monthly charts.

3. Economic crises or major recessions caused by systemic risks —a few monthly-level corrections or long-term bear markets fall into this category.

In the past 20 years, the subprime mortgage crisis in 2008 and the public health event in 2020 both belong to the third category. The former fell by 58% in just over a year, and the latter fell by 35% in two months. Therefore, the third situation exceeds our bottom-fishing plan and needs to be analyzed separately.

However, a crisis and a correction are indistinguishable at the beginning . When the US stock market first started to fall in 2007, the market thought it was an economic recession. After the Federal Reserve began to cut interest rates, the stock market rebounded, and by the beginning of 2008, investors had already been buying up stocks at the bottom.

Therefore, during the bottom-fishing process of adjustment, it is also necessary to continuously observe whether anything that did not happen in the early stages of the decline has occurred, or whether the factors that caused the initial decline have worsened.

Take the recent deep declines as examples: a standard bear market like the one in 2022, which saw a 27% drop in a year, is actually the easiest to identify. It is driven by standard macroeconomic logic, everyone is talking about interest rate hikes, all prices are soaring, and every month there is data telling you that this month is worse than last month. At most, bottom-fishing will result in losses at the beginning of confirmation, but you will naturally realize later that this is a protracted battle and requires a longer bottom-fishing period.

A sharp drop like the 36% plunge in a month during the 2020 public health crisis, which is "unprecedented," is likely caused by a black swan event, not an economic one. It is indeed very panic-inducing in the short term, but once the drop is over, it will be over. In this situation, we can only endure it.

The most difficult was the 58% drop during the 2008 financial crisis. This was actually a combination of the two situations mentioned above. In a normal recession, a crisis event occurred that triggered a deep recession and bear market. It was unpredictable and could only be dealt with.

Going back further, the dot-com bubble burst in 2000 was a rare crash caused by overvaluation, which in turn dragged down the economy. However, the valuation level at that time was indeed much higher than it is now. It was a predictable "gray rhino" event, but no one wanted to "get off the bus first."

Considering the similarities between these different types of US stock market declines, you'll find that you shouldn't try to predict a decline in US stocks in advance. The most important thing is to face reality and deal with it after it happens. The sky isn't going to fall.

Of course, not making predictions and taking timely and correct responses after they happen requires you to pay attention to the market. You can't just allocate assets without managing them like you would with wealth management. You still need to assess whether the market is likely to turn into a crisis after it has fallen to a certain level.