Is ‘Sell The Bounce’ A Good Investing Strategy?

with No Comments

Among the folk wisdom about how to invest is the idea that investors should get out of investments after a short-term rally. This philosophy is encapsulated in the adage, “Sell the bounce.”

The idea that you can sell when the market rallies presumes that you somehow know that this rally is a short-term rally in the middle of a medium-term downturn in the markets. But what if that is not the case? What if this supposedly short-term rally is actually the major recovery? In that case, you will have sold early and missed out on most of the growth.

“Selling the bounce” assumes that some current downward trend will continue unchecked for awhile, but that isn’t the way markets move. What has happened in pricing is irrelevant to what will happen going forward. Prices go down now because more people are currently selling than buying. The fact that more people sold yesterday is irrelevant to today’s pricing.

When stock prices get low enough, they will attract new buyers. When more investors convert to buyers, the drop finds resistance and the stock price will level out.

Prices only continue to drop if more investors decide to sell.

This is why stocks don’t move in a straight line and why the markets are inherently volatile. Investors sell. Investors buy. Prices move accordingly. It is best to stay calm throughout it.

Selling during a rally is most appealing when the market has gone down recently. During a significant downturn, many investors long to do something to stop the losses. It seems foolish to get out of the markets on a day with extreme losses. “Sell the bounce” makes us feel good about a foolish decision. It appeases our emotions while tricking our minds into thinking that we did not sell out of panic.

However, “sell the bounce” is still panicking. It is panicking on a day that featured some small gains.

On average, the stock market trends upward. On average, selling and getting out of the markets will be worse than staying invested and remaining calm.

“Sell the bounce” assumes that there is a value that the market is heading toward which is lower than the current market value. There is no number the market is heading toward and if there is one history would suggest that it is higher.

“Sell the bounce” feeds off the feeling that market prices have their own momentum, but that is not the way that markets are made.

“Sell the bounce” is extremely vague. It does not state how large of a bounce to look for or over how long of a time period would trigger the sell. It does not specify what we are supposed to do with the money generated. Leaving that money in cash risks not keeping up with inflation.

“Sell the bounce” is the corollary to the strategy “Buy on the dips.”

In “Is ‘Buy On The Dips’ A Good Investing Strategy?” I analyzed market movements and found:

After a week with a negative return, there is, on average, a 0.23% positive return the following week. Meanwhile after a week with a positive return the subsequent week has, on average, only a 0.12% positive return.

To be clear, this means you should invest in the markets as soon as possible. Every week you delay investing after a negative week in the markets you lose, on average, the missed opportunity of a 0.23% return. Meanwhile every week you delay investing after a positive week because you are waiting for a dip before you buy, you lose, on average, the missed opportunity of a 0.12% return.

Thus, this study suggests that there is no benefit to delaying your investing. On average, investing is always better than not investing.

Investors who sell after a positive week and sit on the sidelines for the next eight weeks waiting for the market to go down will on average lose 1% of missed opportunity in the markets. Those who are waiting because there was a dip in the markets on average lose even more.

None of this seems significant when you are in the middle of a Bear Market. When you are in the middle of a Bear Market, you can trick yourself into believing that the market will, of course, go down for the rest of this week. But nothing is inevitable in the markets. They might go up tomorrow.

Anyone can always find a reason to get out of the markets, but when will you get back in? For most investors who pull out, they stay out until the market is trading well above the valuation when the got out. We believe timing the market is impossible to predict and success is only luck.

Money invested in the markets, on average, makes more money than if it were not invested. It is a good time to invest regardless of whether the markets are up or down. It is always a good time to have a balanced portfolio.

You should not sell or buy on a dip, and you should not sell or buy on a bounce. You should only rebalance, remain invested, and remain calm.

Photo by Mark Rabe on Unsplash

Follow David John Marotta:

President

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. Favorite number: e (2.7182818...)