Hindsight is always 20/20.
When stocks plunge 30 or 50%, an investor who decided to hold on to his stocks long term looks back and thinks:”Should have sold earlier to lock in the profits while I had them.” Next time when stocks decline 10% the investor sells as a precaution but the decline ends abruptly and stocks turn higher, leaving the investor behind so he swears to hold on to his stocks again next time. Another investor buys stocks after a 10% decline and makes a quick and easy profit when the market turns back up. Next time when he repeats the exercise and buys when stocks are down 10%, the market promptly falls another 30%, leaving him with a sudden loss. Damned if you do, damned if you don’t.
If you recognize yourself in these scenarios, or can add one of your own, you are not alone.
Things in investing are never easy, and stocks never offer an instant replay. Each time you begin to think you know how things work, the market throws you a curveball. So what do you do?
Nobody knows how bad a market decline will get when it first starts. The market does not wake up one day and announce to the world:”I am going to decline 27%, today is the first day, you’ve been warned.” Some declines are mild and end fast; others can feed on themselves and become devastating. The best you can do is to have reasonable rules and apply them consistently. Sometimes they will work for you, sometimes against you, but on balance following the rules is better than having no rules at all and relying solely on your gut feelings.
Do Not Average Down
First things first. Do not buy more until the previous purchase is showing a gain. It’s OK to add to your positions on a pullback but the pullback must still be above your previous purchase price. Following this simple rule can save you from major losses when you buy on a 10% pullback only to see your stocks decline another 30%.
Use Stop Losses
Have stop loss orders in place and do not deviate from them. If you are not certain, ladder your stops – i.e. place them under several recent support areas. This way you replace guesswork and raw emotions with discipline.
Buy Back Higher
If you sell as a precaution and the market turns back up, consider the lost profit as an insurance policy against a bigger decline.
Use Partial Buys and Sells
When not certain, you don’t have to make all-or-none decisions. Use partial buys and sells. If you don’t like the market – sell some. If things get worse – sell more; if things improve – buy back. Of course, this assumes that you follow the rules for proper buying based on stock price and volume action.