“Should I Sell Stocks? When Should I Sell Them?”
Friends, family, and others have been asking a lot of these questions recently.
A crash is typically defined as a drop larger than 20% in a major index, notably the Dow Jones, SP500, or Nasdaq indices.
Time is money.
Let’s do this how we usually do – facts and figures.
One of the major functions in the Laissez-Faire algorithm revolves around Fibonacci retracements. Fibonacci retracements are based on the ‘golden ratio’ first mentioned by Leonardo Fibonacci 800 years ago. If you’re not interested in the significance behind the beauty of math, or 12th-century mathematicians; feel free to skip this part.
Fibonacci discovered a novel mathematical sequence when looking at a problem of rabbits.
The problem, dealing with the regeneration of rabbits, calculated the number of
rabbits after a year if there is only one pair the first month. The problem states that it
takes one month for a rabbit pair to mature, and the pair will then produce one pair of
rabbits each month following. Fibonacci’s solution stated that in the first month there
would be only one pair; the second month there would be one adult pair and one baby
pair; the third month there would be two adult pairs and one baby pair; and so forth.
When the total number of rabbits for each
month is listed, one after the other, it generates the sequence of numbers for which
Fibonacci is most famous, the Fibonacci Sequence:
1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377
While the numbers have unique properties, what is more useful is the ratios derived from them.
The Fibonacci numbers also have a geometric manifestation in the form of the
golden ratio. The golden ratio can be found by partitioning a line segment in such a way
that the longer portion (L) is to the shorter portion (S) as the entire line segment is to the
longer portion. This relationship is generally expressed by the formula:
Using the quadratic equation gives the numerical value for the golden ratio, which is
often denoted by the Greek letter phi.
Now, to not bore you with more math, let’s move to why this matters.
My algorithm works exclusively on statistics, as it’s the only way to quantify an edge in markets.
Using retracements in crashes so often seen in Bitcoin and in the stock market are incredibly useful, because all markets experience a phenomenon of the tendency to move towards these levels. Looking back at historical market crashes, Fibonacci levels are respected for the last 100 years and are incredibly accurate. For 11 out of the last 12 market crashes, the initial drop returns to and rejects from the .5 retracement. That’s 91.5% of the time. 100% of the time it will return to the .382 retracement. Below the most relevant levels are illustrated in colors, .618 being cyan, .5 being green, and .382 being yellow.
The ratio is particularly useful in that it always remains the same, regardless of the anomalies of the market being analyzed.
Lets begin with 1917. The initial crash in 1917 was 20%, and dropped another 33% from the .5 retracement. It didn’t return to those levels until 2 years later.
Next up, 1920. The initial crash was around 25%, followed by another 40% crash from the .5 retracement. It took a little less than 3 years to return to that level.
Then the one we like to forget, in 1930. The initial crash was most similar to our current one in both velocity and percentage drop. In 1930, the initial drop was around 42%, followed by an 86% drop from the .5 retracement. From there, it took 20 years to return to that level. One would have lost money in markets for two decades.
After that, there’s the crash in 1937. The initial drop was around 40%, followed by another 40% from the .5 retracement. It took 6 years to return to that level and 8 years to return to the high. Notice the trend of these crashes; nearly every crash has followed a pattern for the last 100 years.
1988 also has quite a lot of similarities to our current drop.
2000, Nasdaq – We specifically have to look at the Nasdaq chart for 2000, as the crash was specific to technology stocks. The total drop was 90%, and 80% from the .5 retracement.
And finally, 2020. A 38% initial drop, now will it hit the .5 retracement? For the crashes in the last 100 years, it’s happened 91.5% of the time. Notice how it rejected off the .382 initially and was supported by the .236.
There is a lot to be learned from these historical crashes, so I compiled a few snippets of data to help make an informed decision.
The average total drop over the last 100 years is 48%
The average time it took to return to the highs 2760 days, or 7.5 years.
Is this time more severe or less severe than historical crashes?
Now using these statistics gathered let’s answer the questions.
Q: “Should I just keep holding my stocks?”
A: Only if you’re okay with an average of 7.55 years until you get your money back, an 83% chance of lower lows being made (losing more), and an average total drop of 48%(Another 12% below our last low), with outliers being -60-90%.
Q: “Should I be buying stocks right now?”
A: With the indices currently just below the .5 retracement, and a historical 91.5% chance of rejecting off that area – your odds are not good. It would be false to compare this current crash to other “buy the dip” areas that have previously been very profitable for the last 12 years.
Q: “Is the crash over yet?”
A: Unlikely. 83.3% of the time the stock market made a lower low after reaching similar levels.
Q: “If I sell my stocks when should I sell them?
A: As illustrated above, the best place historically is to sell around the .5 retracement. That level is around 24000 on the Dow, 2780 on the SP500, and 8200 on the Nasdaq. However, 38% of the time the stronger bounces will tag the .618 retracement. This is a stronger bounce, and I think it’s possible that it could reach the .618 – but it’s much more statistically sound to sell the .5. If we reached the .618, in my mind that would be the ultimate gift to short – and I will be shorting.
Index Levels to watch:
Dow: 24000, 25300
SPX: 2780, 2920
Nasdaq: 8200, 8550
Q: “Where is the safest place to put my money?”
A: There are many interesting prospects for where to place cash, but currently cash may be the best decision as the dollar is strong amongst all world currencies despite the inflationary actions being taken by the fed and other central banks. Bitcoin is always worth a nibble, as well as hard commodities like gold for the same reasons. They are theoretically a hedge against inflation. Of course, select funds also can outperform the market during downturns, including our own right here.
Happy investing and happy quarantining! I hope this knowledge can do some good for you all.