It worked during the crash of 1987 and through the market collapse of 2007-2009, but most of the time, panic selling ends up being a losing proposition for investors, says David Bianco, chief U.S. equity strategist, Bank of America Merrill Lynch.
"Timing re-entry into the market is extremely difficult, if not impossible," he said in a note to clients.
"Rule based strategies of exiting the market after any major sell-off generally underperform on both short-term and long-term basis as best gains in the market tend to be very close to major sell-offs."
As defined by Mr. Bianco, investors using the "panic selling" strategy exit the market following a one-day drop of 2.5% or more. Investors then stay out of the market for at least 20 trading days until the market is flat or up over the 20 days after the last 2.5% or more down days.
Compared to a strategy of just staying invested, the "panic selling" approach does a good job identifying all major corrections and selling after such days helps to avoid some of the market's worst performance periods, said Mr. Bianco.
At the same time, he said such selling and waiting for the calm to repurchase, results in overall underperformance because some of the market's best days are also missed. The only time in 50 years that staying invested hasn't outperformed "panic selling" was following the October crash of 1987 and the most recent bear market.
"All but 4 of the market's best 50 days since 1960 have come within 20 trading days of a 2.5% down day," the strategist said.
"Sharp down days are useful warnings to carefully reassess the economic and EPS outlook. But if conditions and valuations appear supportive, we think it best to stay invested after sharp down days to benefit from strong rebound days likely ahead."