7 Disastrous Mistakes To Avoid During A Market Downfall
The market has been on a bull run for 9 years now. This is an unprecedented feat. However, there’s now a fear among investors that the market is headed for a bear run. However, there’s no need to fear. With a good strategy and by following a few basic investing rules; bear market investing can really turn out to be profitable after all.
Before we discuss that, here is a summary of what happened some time ago.
Approximately 2 months ago, the Dow Jones Industrial Average (DJIA) marked one of its biggest losses in history. It closed down at 1, 175 points. This was one of the biggest drops in history to happen in a single day. The S&P dropped by 4.1%. The “fear gauge” or CBOE Volatility Index, as it’s known, went up by 115%. This was the highest it has been since 2011.
A lot of leading experts in the industry were quick to point out that the market was simply just correcting itself. However, the DJIA plunged down by a further 1,032 points. The S&P 500 and The Nasdaq Composite also experienced almost similar losses.
As an investor, this means that you need to be extra cautious given the volatility of the market. These huge losses show that there’s lower confidence among investors. Also, the market is less stable in 2018 than it was supposed to be.
Important Rules to Follow So You Can Protect Yourself During a Shaky Market
Here are top 5 investing rules to keep in mind for bear market investing in order to protect yourself as an investor:
Some investors panic when prices start to drop. However, you shouldn’t do this. It could be that the market is correcting itself or a trend that’s reversing itself or a crash. There’s really no way of telling this until after the event has happened.
However, if you panic and decide to completely leave the market, then you will miss out on any opportunities that you might have had to make money. If there was a possibility of you making money but you didn’t take advantage of, then this can be counted as a loss.
In fact, it’s when the market seems to be spiraling downwards that you can make some of your best investment decisions. This is because the prices of stocks will have gone really down and you can buy them at bargain prices. What’s more, there are counter-cyclical stocks, which are stocks whose prices seem to only go up, even when the market is on a downward trend.
Cash is King
Having cash at hand is quite important for bear market investing. This might seem like it’s contrary to rule number 1, but it’s actually not. When you have cash at hand, then you can start looking for huge discounts that you can take advantage of.
During a bear run, most people prefer to sell. You can be able to find some really good deals from companies that have solid business fundamentals and good future prospects. You can take advantage of this situation to buy low and sell high.
During a bear run, if you have cash, then you can be able to buy stock of stable companies. This should be a long-term strategy in order to give stocks time to rise again. Build your portfolio when the prices of the stocks come crashing down.
Spread Your Bets
It’s important that you diversify your portfolio in order to minimize risk. One of the ways to do this is to have cash at hand. You can also invest in other things as well as invest in different industries.
The key idea is for you to invest in other assets that are not directly related to stocks or assets whose value goes up when the value of the stocks goes down.
One such asset is cash which is not directly related to the stock market. However, its biggest risk is inflation. To protect yourself against inflation, you can invest in other assets that are not affected by inflation. This includes gold, real estate and commodities.
There are also counter-cyclical stocks. This includes things like short-term treasury bills. Such assets can help to cushion you against suffering heavy losses.
You can also add some short-term liquid assets to your portfolio.
Control Your Emotions
It’s quite easy to panic when you start seeing newspaper headlines talking about how stocks have dipped. However, getting anxious and panicking are the worst things you can do. You need to keep a clear mind and try to remain rational so you can make rational decisions.
You must know that it’s quite hard to time the market. This is because there’s usually a time lapse before something major happens and when it actually happens and it affects the stock market, it consequently leading to a crash. By the time the crash happens, your opportunity to sell will have passed.
An analysis of 30 years history of the market tends to show that most investors usually buy and sell at the wrong times. In most cases, most cash outflows tend to happen when the market is at the bottom and inflows tend to happen when the market has reached its peak.
In other words, you need to stop blindly following others when you are in the market. In fact, when everyone is selling that’s when you should start thinking about buying and when everyone is buying that’s probably when you should start thinking about selling. Stay ahead of the trend if you want to hit it big in the market.
Have a Stop Loss in Place
A stop-loss order is when you instruct the broker to sell when the stock hits a specific price. This type of order is very useful when you aren’t keeping a keen eye on the market. This way, you will minimize your losses. You can have this order in place for as long as you want. The price at which you decide to put the stop loss order will depend on you. In most cases, most people put it at 15-20% of the peak price of the stock. It largely depends on how much loss you are willing to incur.
However, a stop loss order is not foolproof. In case a stock drops down, the order can be activated when the market opens next. This might be several points below your stop loss order. This is one of the risks that you will have to deal with. When this order is in place, it means that you will only be willing to sell at that price or a better one. However, if you are unable to sell at this price or higher, you might get stuck with the stock for quite some time.
The good thing is that such occurrences only happen when there stock gaps down, and this is quite rare. Despite its disadvantages, having a stop loss order in place can greatly help you minimize your risks in the stock market.
Counter-cyclical stocks tend to move against market trends. When the economy seems to be taking a downturn, counter-cyclical stocks tend to go up in value. This is because the performance of the company is negatively correlated to the economy. During times when the economy is doing good, the prices of such stocks tend to depreciate.
It can be hard to find a counter-cyclical stock since it’s challenging to find a business that would thrive when the economy is getting worse and most people don’t have a lot of money.
A good example of a counter-cyclical stock is an outplacement agency. Such a company will experience a boom in business since most people will be out of work and looking for jobs. This business model would thrive at such times because more people will be out of work during a recession than when the economy is thriving. Buying counter-cyclical stocks can be a good way to protect your investments, as you will gain while other stocks decline.
A lot of investors hardly ever think about counter-cyclical stocks when they are making investment decisions. In addition, sometimes it can be hard to figure out which stock is classified as counter-cyclical. For example, companies that produce alcohol can be viewed as being counter-cyclical, since most people turn to alcohol during hard economic times. However, alcohol abuse can lead to an increase in crime.
In addition, such companies can be severely affected when the economy is doing well. This can be for many years. In fact, many counter-cyclical companies might suffer bankruptcy at some point, if they don’t have strong balance sheets. To invest in such stocks, you have to time the market really well. Get in when the economic downturn is just starting and then sell off when the economy starts getting better. But in some cases, the price of the stock might start going down well before even the market starts experiencing an economic upturn.
The Risks of Investing in Counter-Cyclical Stocks
A counter-cyclical stock can end up underperforming. This is because the economic growth might not always be accurately reflected in the stock market. For example, a small market upswing in a recession can cause a huge market jump. So, while the market might be falling, other areas of the economy might be experiencing a growth and this can affect the price of the stocks.
What is a Stock Market Crash?
A stock market crash happens when there is a sudden and fast fall in stock market prices. This can happen as a result of a catastrophic accident, an economic crisis or a bubble burst. In addition, panic among investors as a reaction to the events that have happened can cause a crash.
In most instances, crashes happen when abrupt double-digit percentage losses in the stock index are noticed in the stock market over a couple of days.
Some of the well-documented crashes in the US history include the 1929 crash due to an economic decline that resulted in investors selling off their stocks, the 1987 Black Monday crash that was caused by mass panic and the 2008 crash that was caused by a recession in the housing and real estate market.
Preventing a Stock Market Crash
After the 1929 and 1987 crashes, a few precautions were put in place in order to prevent a crash from happening as a result of panic selling from investors. This included putting in place circuit breakers or trading curbs to prevent trading activities for a couple of days following a sharp fall in stock prices. This was done to stabilize the market and prevent things from getting worse.
For instance, if the Dow Jones Industrial Average (DJIA) happens to drop 2,400 points by 1 P.M., the market will be frozen for an hour. If it falls below 3, 600 points, the market will be closed for that day. Other countries have also put similar measures in place.
Another way to stabilize the market is by having large corporations buy huge amounts of stock. This is to inspire individual investors to also make purchases and to stop them from panic selling their stocks. Nevertheless, it has not yet been proven whether these measures really work or not.
If you totally rely on stock market investments for your retirement plan, all your retirement savings might be wiped out clean. A drop in equity prices might happen in a day, over many months or even years. In most cases, market crashes are followed by a recession or depression.