October wasn’t a good month for stock markets. The Dow Jones Ind. lost around 7% from its high at the beginning of the month, the Nasdaq around 8%, the S&P 500 around 7%. What to do now when markets fall?
When markets are dropping like they did this month, many people ask themselves what to do now. Selling before their stock are falling even deeper? Buying more of some stocks because they’re cheaper now? Many are unsure if this market drop is the beginning of the next big crash, so selling everything you have could be the best thing to do. Others are trying to take advantage of every setback of the market because they believe markets will still rise more. Acting right when markets begin to fall isn’t easy, but there is a way to deal with it.
The point is, you will never really know when the direction of the market really changes. Even overheated markets can get hotter. And setbacks are part of every upward trend. So, how to act in times like these when the market drops and you don’t know where it will go in the near future? That’s a question of how to manage crises and when to leave the market.
Everyone needs a plan on how to act in a crisis.
May it be a small or a big one. But when you start asking what to do when the market begins to fall, you’ve made a big mistake and you’re in trouble. You’re much too late. Why? Well, just because we overreact in hard times and emotions run wild, our decisions may not be the best ones. Making investment decisions based on emotions is the worst you can do. That’s true for buying and selling shares.
Only a few have the guts to ignore the ups and downs of the stock market. Especially today, when so many young investors with no experience of the crisis 2000 and 2008 fill the market. These market participants only know the markets going up. That’s why they always start to discuss the beginning of a heavy setback when the market drops by 5%. The investment market is like a roller coaster and if you want to be a part of it, you have to deal with this.
You need a plan before you buy
In social media, people often ask which shares would be a great buy. I understand this question, but it’s the first big mistake one can make. It reveals that the asker has no clue of the stock market. If he would have, he wouldn’t ask that question. Deeply connected with this inexperience is the fact that he doesn’t have any strategy. But before one starts investing, one needs a plan, especially about what to do in a crisis. This plan should never be forgotten and one should absolutely stick to it.
What should be part of that plan?
Well, first of all, such a plan needs to be based on knowledge about the markets. Making plans without knowing the basics is stupid. And planning to ask others where to invest the money, is even more stupid. So, learn the basics and learn as much as possible. Never stop learning.
If you have some knowledge about the investment markets, you should start with making clear that you only buy shares at a price well thought through, which implicates that the price shouldn’t be too expensive. Don’t think this is a trivial point. It isn’t. Many private market participants don’t buy based on reasonable criteria. They just buy based on emotions and they often buy spontaneously. So, thinking about the right price is essential.
What to do when the price is falling?
The next point on your plan should be about what to do when the price is falling. For many, that’s the hardest thing to bear. No-one likes to see the price of its shares falling, except maybe value investors. But if you can’t stand a 50% loss, you probably aren’t the right person for investing in the stock market. But I tell you what. I’m convinced that when you have a written plan, it will be much easier for you to stand tough times. This written plan helps you to act rationally instead of emotionally.
So, think about what will be the lowest share price that makes you happy, because you are able to buy more of the shares. Up to this point, you have no reason to worry. The next step would be to think about the price which should make you think that you could be wrong with your assessment. This will be the time you really should check your buying criteria and if you really made a mistake regarding your assessment of the company. For this case, you should have set a price where you leave the market and sell that stock.
Making mistakes is part of the game
I’m convinced that if you researched a company well enough and you decide to buy it and hold it for a long haul, you don’t have to sell the company even when the markets are down. In bear markets, the price doesn’t reflect the quality of the company. That what prices mostly do. Sometimes they’re much too high, and sometimes much too low. That’s why value investors don’t take the share price too important. They prefer to look at the value of the company.
But, from time to time it may happen that you make a mistake and the company you choose isn’t as good as you thought. In this case, you need to sell its shares and correct your mistake. Don’t forget! To minimize the risk of such a mistake, you only buy with a reasonable margin of safety. But you need to know the lowest price for correcting your mistakes. Write it down and do it before you buy.
You will never make it without a plan
It’s hard to get through bear markets without a plan. This happened to me 2000 during the dot.com bubble. Because I acted without a plan, without enough knowledge, just based on my emotions and the actions of others, I lost much money. After that crash, I made a plan and I stuck to it even in the crash of 2008. That plan helped me to get through this crisis and to participate in it.
A plan, for good and bad times, helps you to think with patience and rationally. It helps you to make decisions that are not driven by your emotions. It helps you to get rid of some companies and replace them with better ones. Don’t forget that in a market crash even great companies are cheap and this could be the only chance for you to buy them. Such a buying decision can’t be made upon emotions. as I said before, the plan helps you to make better decisions in times where your emotions want to take the rudder. The intelligent investor has a better portfolio after a crash than before.