The following is a guest post from Alexander of daytradingz.com. In 2016, he launched his blog to share his experiences with short-term investments with his readers and to reveal insights regarding the products and services in this business.
If you’ve been keen on the business news, you might have come across one or a couple of headlines warning you about a possible drop in the price of a specific stock or the other. If you’ve ever seen such headlines and panicked, then this might just be the article for you.
One of the worst headlines in The Wall Street Journal a few months ago on February 5h 2018 screamed: “Dow Drops More Than 1,100 Points in Stock-Market Rout”. Everyone was immediately thrown into a state of confusion marked by fear and uncertainty. Some people ended up selling their positions unnecessarily.
The stocks will always go up and down. Nobody really knows for sure the trend of any commodity. Remember, from the day when the WSJ published this article the Dow Jones Index moved sideways for a while and then went up from ~24,000 points to the all-time high in September 2018 at 26,966 points. This is a gain of more than 10%.
Yes, the markets will fall again. That’s part of the game. To give you a better perspective of the shifting of market prices, let’s go back to the 80s and analyze the Dow Jones index…
A Brief History of Market Corrections
The biggest challenge faced by investors during a fall in prices is always psychological — but in such circumstances, it is always wise to stay calm, cool, and collected. Otherwise, you can forget it, because the markets will chew you alive.
One of the darkest days of the stock markets popularly known as the black Monday is on October 19th, 1987. On this fateful day, one of the world’s famous indices, Dow Jones Industrial Average lost more than 20% of its market value.
Every business journal floated the possible explanations about the unexpected shift. Everyone wished they had seen it coming, and as you may imagine, most investment analysts got fired by their clients.
But you need to understand that this is the way of the financial markets. The best you can do for yourself is to prepare for such price shifts adequately.
In this article, you’ll learn how to get through market corrections (regardless of the reason) better than anyone else.
Let’s get started!
Never Try to Time the Stocks
It’s not surprising to see investors checking their brokerage account on a regular basis dumping one stock or the other to avoid a market correction. They hope to jump back in just in time for an upward shift in prices. Of course, this is a great strategy and may work; but it’s quite risky.
And here’s the thing: can anyone tell for sure when the right time to jump back into the market is? If anyone did, we’d all be sleeping easy and never losing money, right?
Warren Buffet is one of those people who has managed to play the market corrections, but one thing he advocates for is holding stocks for long stretches.
In short, don’t sell off all your stocks with the hope of cutting your losses in case stocks drop — this is because you could miss out if the stock prices instead keep rising, and even if the correction actually occurs, there is no guarantee that you’ll make it back in on time.
Maintain a Balanced Portfolio
Instead of exiting the market, this might be the perfect time to rebalance your portfolio to enable you to minimize your risk. You can do this by having a mix of investments including bonds and stocks so that when stocks drop, the bonds held can act as a shock absorber.
The same way you have airbags in a car with seat belts, having a mix of stocks and bonds can play a significant role towards minimizing your portfolio’s volatility making it less horrible when a market correction occurs.
An example of a balanced portfolio can comprise of 60% stocks and 40% bonds — and in case you find it challenging to balance your portfolio strategically, consider talking to a financial expert to help you evaluate the various options available to you. But whatever the case, rebalancing your portfolio is unlikely to throw you off the balance when the market goes bearish.
Understanding the market corrections takes a lot of patience to enable you to learn its cycles. If you learn how the stock prices fluctuate, you’ll be better prepared when one occurs.
Most stocks in stable economies have been on their highs in 2018, so even if the market corrected by 10%, there wouldn’t be so much panic among investors.
On average, the market corrections take a few months to recover. Huge corrections are the exception and last longer. Be sure to study the industry of your stocks to enable you to have a more accurate projection of the duration it takes for the price drops to shift back upwards. If, for instance, a specific industry experiences market corrections at certain times of the year when their products or services have a lesser demand, you need to have studied that trend to help you make more informed decisions when the stock prices are likely to drop and rise.
Be careful with short term speculation strategies like day trading. Many investors fail with this approach because of undercapitalization, unreasonable risk acceptance and unrealistic expectations triggered by aggressive marketing tactics.
Maintain a Cash Buffer
Avoid having all your money tied up in the stocks especially when there are signs of a market downturn.
It is vital to set aside a certain amount of money for emergencies, and short-term goals. It’s recommended that one should have an emergency fund capable of lasting for at least six months. Such a cash cushion can help you pull through a market correction painlessly.
Take profits if you are comfortable with in the long run
No one’s stopping you from realizing profits. The important thing is that you have to stand by your decision. A new investment cycle begins with the sale of your shares. It makes sense to realize profits, especially in the case of short-term investments.
For example, if you would like to buy a house and your current portfolio is to secure the loan at the current level, then it is appropriate to realize the profits. This is the safe way. And even if in the following days the market still rises 1 or 2%, this is the better choice. After all, what would you do if the portfolio fell at short notice and the credit protection went down the drain? Use a stock scanneror track your portfolio more often in case you want to ensure the best possible timing. Define your plan first and act based on your plan. When a stock hits his stop loss, then sell the position as planned.
A colleague of mine recently bought a kitchen. During the last days before the purchase, he looked at his portfolio every day. It has fallen in value from day to day. He did not sell at the price that he said where he would sell at latest. In the end he sold disappointed at the temporary low. He already knew that he would have to pay for the kitchen when the markets were in much better shape. Rational decisions are needed in such situations. Greed and fear are of little help.
As you may have noticed, it takes more than just making a market prediction to be able to withstand a market correction. A lot of times you’ll hear experts predicting a possible market crash, and surprisingly, most end up being wrong. And so, if you play into the hands of every prediction you come across, you may end up missing the whole point of investing in the financial markets.
On the other hand, you shouldn’t put yourself at the mercy of the stock markets where in case of a markets crash, your entire investment gets wiped out.
The best possible way to avoid all these would be to maintain a well-balanced portfolio that complements each other in case stock prices drop.
There you have it!
Let us know your thoughts and experiences about market corrections and quite possibly, when you think the next market crash is likely to occur and how to prepare for it.
Originally published at yourmoneygeek.com on December 26, 2018.