How to Pick Up the Pieces After the Market Sinks
Drops always occur much faster than gains, but you can take these steps to make the losses less painful.
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One of the most frustrating things investors experience is that after months of building up some sizable gains, profits disappear in a matter of days when a correction suddenly hits. It is a bumpy escalator ride up and an express elevator ride down.
The recent market action is a particularly good illustration. In just three weeks, the S&P 500 has dropped more than 10% and is back to the same level it was six months ago. Many individual stocks have suffered an even steeper dive and given back substantially more than 10%. Currently, more than 3,000 stocks have dropped 30% from their previous highs.
These corrections often occur so fast that investors are caught by surprise and feel that it is too late to do anything. It is very easy to freeze and do nothing as you sit and hope that things will bounce back. All active investors have found themselves in this position at times. A stock that looked so good a short-term ago has suddenly fallen 300% or more, and now we are confused and uncertain about what to do.
Inertia is not the answer to this problem. Once the damage is done, the hard work of recovery and getting your portfolio back to new heights begins. There is no easy way to do this. You just have to slog along day after day and chip away at the losses.
What do you do if you missed making a sale and now are sitting on a big loss? Do you just sit and hope that your stock will eventually rebound?
The best way to approach the situation is to use mark-to-market thinking. Instead of focusing on the fact that you are sitting on a huge loss, imagine that you bought the stock just now at the current price. Forget your original cost basis and treat this stock like a fresh buy, but this time, you are going to have a very clear plan on how to handle it. You will stay disciplined, and if your new stop level is hit, then you will dump it and move on, but if the stock starts to act better, then you can add to the position and start taking some partial profits. The important issue here is forgetting what happened in the past and focusing on what is in front of you right now. You can have a fresh start anytime that you like.
The single best advice that I can give an investor is to try to keep your accounts as close to highs as possible. There are two reasons for this. The first is that there is nothing that is more unproductive than having to make up losses. If your account is down 50%, then you need to double your money just to return to even. That is a tremendous amount of work to return to where you were previously.
The second reason to focus on keeping accounts at the highs is that you make big money in investing by compounding. Compounding is nothing more than generating profits on top of your profits. That is why Warren Buffet is a multi-billionaire. Albert Einstein called compound interest the eighth wonder of the world. If you are spending all your time making up losses, then you aren’t compounding.
Focusing on keeping your accounts as close to highs as possible is easy advice, but actually, doing it is extremely difficult. You have to allow some room for pullbacks due to ordinary volatility. If you are too eager to dump anything with a minuscule loss, then you will never have any winners.
The first step is to make sure you have a very clear plan for cutting stocks that are not behaving. I tend to use several stop levels, which force me to gradually reduce my exposure to a stock that is slipping.
The mindset of keeping accounts at highs only works if price action is your No. 1 consideration. You can’t justify holding stock for its fundamentals and ignore price action if you want to keep your accounts near highs. Price action has to be the focus above all other considerations.
When I have a stock acting poorly, I continue to like it fundamentally. I will reduce it and keep on trying to add it back at a lower price. If it keeps sinking, then I will sell it again and then wait for the chart to improve. I may have a series of small losses in the name before it finally starts to do what I hoped, but if the losses are small, then my capital is not impaired.
Sudden market corrections are very difficult to deal with, but they are inevitable. There will always be a slow escalator of gains and then a sudden elevator of losses.
At the time of publication, DePorre had no position in any security mentioned.
