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Tales of a Technician: The Ultimate Capital Deployment Scheme

February 3, 2016

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Everybody agrees buying stocks during a fire sale is a killer idea for long-term investors. Just jump in the way back machine, head to 1987, 1998, 2002, or 2008 and buy up equities with abandon, right? We all like buying big bottoms (and we cannot lie). And in hindsight, they’re sooo easy to spot.

In real-time? Not so much.

Given all the whizbang advancement seen in the world of analyzing financial markets we’ve yet to come up with an effective way at predicting both the duration and magnitude of bear markets. And, spoiler alert, we never will.

Tales of a Technician: The Ultimate Capital Deployment Scheme

See, we never know which 5% pullback will morph into a 10% correction, and which 10% correction will grow to a full-fledged bear market (20% drop). And which 20% drop will snowball into a hold-me-mommy crash of 40%.

Sure we know the average length and how frequently bear markets strike. But that’s about it, friends.

So, say you have a wad of cash, an opportunity fund, ready for deployment in times of market turmoil. “I want to be a rockstar,” you reason. I want to be one of the cool kids that can say I bought stocks during a bear market so that two or three years hence when the market has gone on to new heights I can look back with pride and tell my kids, “see that mega crash, son? Your pappa bought the crap out of stocks back then cause that’s how he rolls. Now let’s go buy some ice cream with all my winnings.”

Just kidding. Don’t word it that way. Kids remember your language and that’s horrible English. Say it in a dignified, sophisticated manner. But say it nonetheless.

So when do you invest the cash? When the market falls 5%? 10%? 20%? 30%?

Yes. Yes. Yes. And yes. All of the above. I know what you’re thinking. Why not just wait until we’re down 20% or 30%, and then deploy it all? Well, because downturns of that magnitude only arise every four years or so. Do you really want to sit on cash for that long? The opportunity cost is likely not worth it.

Okay, okay. So just throw it in when we’re down 5%, right?

Nope. Then you feel like an idiot when that 5% drop turns into a 20% drop and you haven’t any more greenbacks left to deploy. Here’s the approach I suggest, one that excels in regret minimization. Divide that glorious war chest of money just waiting to go to work for you into tranches. You decide how many and what percentage in each. The following is for illustration purposes only.

Let’s say I divide my hoard into four piles of 25% each. The first pile I deploy when the market is down 5%. The second goes in when we’re down 10%. The third goes in when we’re down 15%. The final goes in when we’re down 20%.

Think of the benefits. I’m adding capital during each and every significant pullback. But I’m not deploying all of it until we reach the 20% threshold. Obviously, you can switch things up to fit your preference. Maybe your final tranche goes in at 25% or 30%. Whatever. Just remember we don’t get really, really big downturns that frequently so if you’re trying to wait for a 40% drop before you put new money to work then you may be waiting for years on end.

Now, the logistics for determining these thresholds. Simply take the market peak and multiply it times 0.95, 0.90, 0.85, and 0.80. The S&P 500 peaked on May 20th, 2015 just shy of $2135.

  • A 5% drop would take us to $2028
  • A 10% drop would take us to $1922
  • A 15% drop would take us to $1814
  • A 20% drop would take us to $1708
SPX
Source: OptionsAnalytix

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6 Replies to “Tales of a Technician: The Ultimate Capital Deployment Scheme”

  1. Brien Hodgman says:

    I like it Tyler. It is hard to be logical when everything is falling dramatically but level heads prevail.

  2. Thomas Hammonds says:

    I agree Brien! Good article Ty!

  3. Bill Trimborn says:

    Interesting article, Tyler! I had to look up “tranche” in the dictionary. How long have you been waiting to use that word? 😉

  4. ERICSIMMS says:

    Well said, I think this is the big opportunity of a decade, our decade to decide how we will emerge from the fray victorious.

    Best regards,

    Eric

  5. Tyler, I’m your fan.

  6. Kitna Rhea says:

    Thanks Tyler! Love your writing style, and you always have great insight.

Comments are closed.

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