Posted by on Sep 7, 2015 in Articles & Advice, Blog, Columns, Featured |

Image Credit: Christophe Vorlet

By Jason Zweig | 11:04 am ET  Sept. 4, 2015

While the sharp swings in the stock market in the past couple of weeks have scared many investors, others have been buying. But you can hit snags when you bottom-fish, so the key is to act on a plan rather than out of instinct.

The day after the Dow Jones Industrial Average dropped more than 1,000 points in intraday trading, Donald Sheeler moved to snap up $6,000 worth of Vanguard Total Stock Market Index Fund for his daughter. The Dow was about to close down another 200 points, and Mr. Sheeler, a 68-year-old retiree in Sarasota, Fla., wanted to buy “when blood was in the streets.”

He put in a buy order at 3:45 p.m. on Aug. 25 using Charles Schwab & Co.’s online brokerage.

Mr. Sheeler had “a hunch” the market would recover quickly — and, sure enough, the Dow shot up more than 600 points the next day. And that, it turns out, was when Mr. Sheeler’s order was executed — not at the lower price he had expected to lock in the day before. He says that delay raised the cost of the trade by approximately $210.

Schwab’s website says the firm will execute trades in “most mutual funds” at 4 p.m. Eastern time on the same day the order was placed. A Schwab spokeswoman says only 351 of the more than 16,000 mutual funds available through the firm have a 3 p.m. cutoff; 274 are Vanguard funds. Similar early cutoffs exist at other brokerage firms, says Vanguard.

Mr. Sheeler learned an important lesson: Before you act on a hunch, check the fine print.

When it comes to bottom-fishing in volatile markets, setting up procedures in advance is crucial. It’s easy to imagine that you will remain calm during the next panicky day — or week or month — in the markets. But when the next panic hits, you may well get swept up in the same emotional maelstrom as everyone else.

Here are a few rules that can help keep you from making seat-of-the-pants decisions.

Build a checklist that includes criteria like these: Buy as needed to keep your allocations to various assets at pre-set targets. (If, for instance, you aim to have 60% in stocks, a 10% market drop would require you to buy more to get back to that level.) Sell no investment that declines at least 10% without first determining whether the drop has made it more desirable to buy than sell. (What, if anything, has fundamentally changed other than the price?)

Work from a watchlist. Michael Shearn, a money manager in Austin, Texas, and author of the book The Investment Checklist, suggests tracking a set of investments you would love to buy if they fell in price. Some might be assets you already own and wish you had been able to buy more of; some might have been recently battered into bargains; others might usually trade at premium prices and have finally become reasonable.

You could start by looking at recent losers. According to Morningstar, 702 out of 3,640 U.S. stocks with a stock-market value of at least $100 million are down between 20% and 50% so far this year — including such stalwarts as Chevron, Molson Coors Brewing and Wal-Mart Stores.

Using a watchlist “changes you from being reactive to being proactive,” says Mr. Shearn. “You can say, ‘Let’s go shopping and see what’s on sale.’”

When you can, buy losers by selling stinkers. To fund your new holdings, unload any investments you no longer believe in, harvesting a tax loss to boot. You can use those realized losses to offset up to $3,000 of ordinary income.

Finally, trade seldom — but, when you do, trade smart. Check in advance to see how late in the day you can buy a mutual fund and still get that day’s price. Avoid buying individual stocks or exchange-traded funds during the first hour (9:30 to 10:30 a.m. Eastern time) or last half hour (3:30 to 4 p.m.) of trading, when prices can be especially prone to big swings.

And always use “limit orders” stipulating the highest price at which you will buy (or the lowest at which you would sell).

On Aug. 24, the day the Dow dropped 1,000 points, it materialized that some financial advisers don’t use limit orders when trading ETFs. “There are still a lot of advisers who built their practice on mutual funds and have never really been through the wringer on trading ETFs,” says Dave Nadig, director of exchange-traded funds at FactSet. “This volatile market is unforgiving for people who don’t know what they’re doing” — and their clients.

So, if you use an adviser, make sure he always uses limit orders when trading ETFs. He can’t bottom-fish for you if he doesn’t know how to use the equipment.

Source: The Wall Street Journal