There's a 54% chance the stock market will go up tomorrow. That's the historical probability that stocks will rise in any given day. Usually daily movements are modest. But what if tomorrow, the stock market doesn't just tick upward? What if tomorrow is the day the stock market skyrockets to levels we've never seen before? Here's exactly what to do (and what not to do) when the stock market rallies.
1. Make a stock watch list
Of course you know you're supposed to buy low and sell high. But let's acknowledge that it's hard to contain your exuberance after a banner day. Now is the perfect time to make a stock watch list so that you're ready to pounce when the market dips.
But successful investors don't buy stocks because of what happened in a single day. Every stock you're seriously considering needs an investing thesis. Ask yourself whether that company is keeping up with broader trends and just how wide its economic moat is.
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2. Consider why stocks skyrocketed
Think back to late summer. How many times did the stock market rally because investors got overly excited about another stimulus bill that never came to fruition? On the flip side, sometimes the stock market soars for good reason. Take March and April. The stock market panicked over COVID-19. But even back in March, few believed that humanity was doomed or that we would be trapped at home forever. The stock market rallied because many investors considered what was happening in the big picture and jumped at the long-term opportunity.
The stock market basically tells us what investors think is going to happen. Other investors can't predict the future any better than you can. So it's essential to keep your perspective. Avoid making any drastic moves on a single-day rally. It may not be based in reality.
3. Do what you put off when the market was down
You never want to sell stocks after a bad day -- whether you're doing so out of panic or because you need cash. But when stocks are on a tear, it's time to do what you were putting off in a down market.
If you need to rebalance your portfolio, do it now while stocks are high. Now is also a good time to rid yourself of any stocks you've been wanting to sell. The same goes for selling part of your portfolio because you have a short-term need, even if you don't have specific stocks you want to unload. As a general rule, you don't want money invested in the stock market that you expect you'll need in the next five years, so it's best to cash out on the upside.
4. Check out defensive stocks
If you invest in the latest growth stock that's in the headlines, you'll overpay along with everyone else. But if you're interested in any defensive stocks, meaning the ones that tend to perform at the same level or sometimes even better during a bear market, this could be the time to buy. Examples include utility stocks and consumer staples stocks, because people still need electricity and groceries no matter what happens in the economy. If you suspect the market is overpriced and you believe investing in gold stocks could be a good hedge, perhaps it's time to put a small percentage of your portfolio in the yellow metal.
5. Go ahead and buy if you see value
Back to that stock watch list. Are you truly confident in your investing thesis? Would you still want to own that stock if its price suddenly tanked by 20% or 30%? If the answer is no, that stock isn't even worthy of a place on your watch list. But if the answer is an unabashed "yes," go ahead and invest if you want. Don't worry that you've missed the bottom or that you're overpaying a bit.
Otherwise, the best solution is to ignore all the hype and stick with your investment strategy. While the odds of the stock market going up tomorrow are slightly better than if you flipped a coin, historically, the market's been up 88% of the time in any given five-year period, and 94% of the time after 10 years. The bottom line is, you don't need to do anything special in a rally if you're already well-positioned in your portfolio.
