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Dealing With Stock Market Corrections: Ten Do's and Don'ts

A correction is a beautiful thing, simply the flip side of a rally, big or small. Theoretically, even technically I'm told, corrections adjust equity prices to their actual value or "support levels". In reality, it's much easier than that. Prices go down because of speculator reactions to expectations of news, speculator reactions to actual news, and investor profit taking. The two former "becauses" are more potent than ever before because there is more self-directed money out there than ever before. And therein lies the core of correctional beauty!  Mutual Fund unit holders rarely take profits but often take losses. Additionally, the new breed of Index Fund Speculators is ready for a reality smack up alongside the head. Thus, if this brief little hiccup becomes considerably more serious, new investment opportunities will be abundant!

Here's a list of ten things to think about doing, or to avoid doing, during corrections of any magnitude: 

1. Your present Asset Allocation should be tuned in to your long-term goals and objectives. Resist the urge to decrease your Equity allocation because you expect a further fall in stock prices. That would be an attempt to time the market, which is (rather obviously) impossible. Asset Allocation decisions should have nothing to do with stock market expectations.

2. Take a look at the past. There has never been a correction that has not proven to be a buying opportunity, so start collecting a diverse group of high quality, dividend paying, NYSE companies as they move lower in price. I start shopping at 20% below the 52-week high water mark... the shelves are beginning to become full.

3. Don't hoard that "smart cash" you accumulated during the last rally, and don't look back and get yourself agitated because you might buy some issues too soon. There are no crystal balls, and no place for hindsight in an investment strategy. Buying too soon, in the right portfolio percentage, is nearly as important to long-term investment success as selling to soon is during rallies.

4. Take a look at the future. Nope, you can't tell when the rally will come or how long it will last. If you are buying quality equities now (as you certainly could be) you will be able to love the rally even more than you did the last time... as you take yet another round of profits. Smiles broaden with each new realized gain, especially when most Wall Streeters are still just scratchin' their heads.

5. As (or if) the correction continues, buy more slowly as opposed to more quickly, and establish new positions incompletely. Hope for a short and steep decline, but prepare for a long one. There's more to Shop at The Gap than meets the eye, and you run out of cash well before the new rally begins.

6. Your understanding and use of the Smart Cash concept has proven the wisdom of The Investor's Creed (look it up). You should be out of cash while the market is still correcting... it gets less scary each time. As long your cash flow continues unabated, the change in market value is merely a perceptual issue.

7. Note that your Working Capital is still growing, in spite of falling prices, and examine your holdings for opportunities to average down on cost per share or to increase yield (on fixed income securities). Examine both fundamentals and price, lean hard on your experience, and don't force the issue.

8. Identify new buying opportunities using a consistent set of rules, rally or correction. That way you will always know which of the two you are dealing with in spite of what the Wall Street propaganda mill spits out. Focus on value stocks; it's just easier, as well as being less risky, and better for your peace of mind. Just think where you would be today had you heeded this advice years ago...

9. Examine your portfolio's performance: with your asset allocation and investment objectives clearly in focus; in terms of market and interest rate cycles as opposed to calendar Quarters (never do that) and Years; and only with the use of the Working Capital Model (look this up also), because it allows for your personal asset allocation. Remember, there is really no single index number to use for comparison purposes with a properly designed value portfolio.

10. So long as everything is down, there is nothing to worry about. Downgraded (or simply lazy) portfolio holdings should not be discarded during general or group specific weakness. Unless of course, you don't have the courage to get rid of them during rallies... also general or sector specific.

Pre and Post Market Trading

9 comments:

  1. Hoarding 'smart cash' is a no no. Every market correction always presents an opportunity.

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  2. A good habit to form is to identify new buying opportunities using a consistent set of rules. Switching unnecessarily from what you're used to can spell disaster.

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  3. These are tips that traders should be serious about, I totally agree that people should try to identify new trading opportunity but still with the previous buying rules and go only for stocks that are less risky.

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  4. I am new to stocks so I may need these tips. Not saying that I will be industry for sure but at least it will not be new to me.

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  5. I learn things about stock by going through your blog and I make bold to say that i have been able to get some knowledge.. Thanks for this tips...

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  6. Stock investments and trading is a very crucial area that needs you to be prepared. I have just noticed with your article.

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  7. These are things that people still forget sometimes when dealing with stock investments. It's really great that you have put together such an informative article about what to do and what not to do when doing stock market corrections.

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  8. This is so informative!Will definitely use these tips on my next trading.

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  9. This tend to sum it up for me Examine both fundamentals and price, lean hard on your experience, and don't force the issue.This is so true experience teaches alot.

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