How Do You Know When to Invest in a Down Market?

August 22, 2007

As you watch your investment holdings quickly diminish over the course of a few days it is easy to panic.  You might give some thought to trying to cut your losses and sell but if you’re a long term investor this is likely not in your best interest.  In fact, when the market is down is the best time to buy.

… it always feels a lot better to buy when the market is going up. But you make more money buying when the market is going down
[The Long and the Short of Down-Market Investing]

… if you invest regularly and have some time before retirement, bear markets can be a beautiful thing.
[Down Markets Good for Many Investors]

Here is my question. How do we gauge when the market slide has finished?  The chart below is pretty obvious in hindsight but in the heat of the moment of the market decline you never really know where the bottom is. 

BuyLowChart


Dollar cost averaging is how I currently put money into my investments but am considering buying more when they’re on sale. So how do I know when to buy into a down market? 

StockMarketDrops

The chart above shows the price of an S&P 500 Index, Vanguard 500 Index (VFINX), since the Fall of 2002, with 14 occasions where the market had a noticeable drop.  It’s not very scientific; I just eyeballed some low points.  Thanks to Google Finance I was able to look at the price before the drop and the price after the market decline. 

The table to the side shows the percentage change in the price of the index after each occasion. One rule I could use to decide when to buy into a down market is to only buy after the index has dropped by a certain percentage.

I would have bought at almost each one of these dips if I set my benchmark to any decline over 3% but would have only invested in 6 of them if I decided to wait for drops of 4% or more and only 2 of them if I required at least a 5% downturn.  I’m not sure which percentage I should settle on but I do know the latest drop in prices looks to be the second largest in 5 years.

Of course, another thing to consider is that the market has been on an overall upward trend over the last 5 years. I’ll have to also take a look at buying in the dips over a 10 or 20 year period to see what that turns up.

What are some other ways you use or know of to help determine when to buy in a down market?

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Ben

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Ben
Ben Edwards, the founder of Money Smart Life, saved up enough to buy a Nintendo back when he was 12 years old. When he used the money to buy shares of Wal-Mart stock instead, he knew he wasn't like the other kids... His addiction to personal finance has paid off for his family and now he's helping you to afford the life that you want. Check him out on the web at Google Plus, Twitter and Facebook.

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10 Responses to How Do You Know When to Invest in a Down Market?

  • John Murphy

    There’s a good article at Investors Daily Edge for the 27 August called ‘Beware of the Pattern on the S&P’ that might give some more insight into buying signals. Nice blog you have here.

  • Ben

    I agree MoneyNing, I’m already doing that with dollar cost averaging. What I’m looking at is putting in additional money and any metrics I can use to help me decide when to put it in the market.

  • MoneyNing

    It’s very easy to see in an analysis on history that you need to buy when the market bottoms but in real time it is very tough since you don’t know if the next day will be another day of decline! You might buy some when the market goes down but it might go down further. Since we don’t have unlimited money on the sidelines, it’s hard to follow the buy on the dip advices even if you truly believe in it.

    Therefore, what KMC said is a good strategy in the real world, buy when it goes up and buy when it goes down.

  • Ben

    Plonkee, where can I get one of those time machines? Do they sell them on eBay : )

    KMC, do you buy once a month or more often than that?

  • KMC

    I just buy all the time.

    Market goes up – I buy. Market goes down – I buy.

    Every month…I buy.

  • plonkee

    A time machine.

    I was going to suggest a tardis, but I think there are rules against that.

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