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

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.

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?

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?