The financial markets have been moving in predictable patterns of late, so it can be hard to imagine the panic that sets in when they start behaving more erratically. Panic is a common human emotion, and can easily take hold when we face the prospect of losing money.
The kind of market that invokes panic will happen at some point in the future — it always does.
We just can’t know when, or what the details will be. But there are steps you can take to help you keep a lid on panic, no matter what the market is doing.
1. Keep Your Emotions in Check
When the stock market is moving in a gradual upward pattern — as it has been for the past five years — it’s easy to keep your cool. After all, there really hasn’t been much to panic about for a long time. That’s why this is an excellent time to remind ourselves that stock markets don’t always move in predictable patterns. They can go down as well as up, and there’s absolutely nothing unusual about this outcome.
What’s really important is we learn to keep our emotions in check when the market starts moving downward. The entire reason why it’s possible to achieve investment gains worlds above what you can get on fixed income investments is precisely because the stock market involves risk. This risk presents a double-edged sword — the compensation for risk leads to incredible returns, but the flip side is risk can also play out in very negative ways.
The point is, investing in the stock market involves a healthy dose of risk. You have to be mentally and emotionally prepared to deal with this.
The best returns come to those who stay in the market year after year, no matter what the market is doing. Riding out downturns is an integral part of the process of achieving superior investment returns over the long run.
2. Make Liberal Use of Stop-Loss Orders
You can also use stop-loss orders as a way to remove emotion from efforts to limit the losses you might take in a declining market. A stop-loss is an order you place with your broker that will have your stocks sold once they fall to a certain point. You can set the stop-loss at a fixed dollar amount, or base it on a percentage.
Let’s say you bought a stock at $50 per share, and it has since risen to $100 per share. By setting a stop-loss at $80, you will preserve a healthy gain on your investment, without panicking out of the stock — which may never even be necessary.
Emotions can complicate selling stocks, even in a down market. Fear of selling out of a stock that has done so well for you in the past could cause you to chase the stock all the way down to the point where you take a loss on it. The stop-loss takes human error out of the picture, and automatically triggers the sale at a price that will still include a large gain.
3. Liquidate Specific Holdings Causing Distress
If you are at all concerned about a prolonged downturn in the stock market, you can liquidate any holdings making you particularly nervous. If you have certain securities that have struggled even during a bull market, you might want get out of them before a downturn sets in.
Stocks that fail to participate in a bull market can get seriously clobbered in a bear market. As orphans in a strong market, they’ll probably get dumped in general market sell off.
By paring out losers and potential losers, you will lower the risk to your overall portfolio, while keeping yourself fully invested in the high performers.
4. Review and Re-Emphasize Diversification
Bull markets cause investors to become sloppy in a lot of areas, particularly when it comes to diversification. After all, if your stocks are doing so well, why bother diversifying? Why not just continue riding the elevator up with the winners you have?
Those are questions that can have brutal consequences in a bear market. It takes discipline to take profits while prices are rising. A lot of investors don’t bother, assuming their ‘trees’ will grow to the sky. But all trees stop growing eventually, and most of them fall. So it is with stocks, and this is why you have to maintain the discipline of diversification even in strong markets.
After a five-year bull run in stocks, now is an outstanding time to rebalance your portfolio and even consider making it more conservative.
Sell off your losers, take some profits on your winners, and move money into income producing assets, such as high dividend paying stocks, and various fixed income type investments. You’ll still be participating in the market, but you’ll be lowering your risk as you do.
5. Continue Contributions and Build Up Cash Reserves
No matter what is happening with the direction of the stock market, resolve to continue making investment contributions. This should apply whether you’re talking about a retirement plan, or non-tax sheltered investment accounts. By continuing to make your contributions — or even increasing them — you will enable your investment portfolio to grow, even if the stock market isn’t rising, and often even when it’s falling.
More importantly, you’ll be building up your portfolio — particularly with cash and cash equivalents — that will put you in a solid position to buy stocks at bargain prices after the market has fallen a good bit.
It’s often recommended you buy on the dips — this is exactly what a down market is, except it tends to be steeper and of longer duration. This just means you’ll find more bargains to buy, and the profits you will eventually earn on them will be that much higher.
Readers: How do you overcome the ups-and-downs of the stock market?