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In last week’s crazy market, we opened Monday morning with the Dow down almost 1,100 points. Then we gyrated up and down the rest of the week. CNBC’s Bob Pisani noted that we took years of market movement and saw it all happen in a matter of minutes.
That’s the first big takeaway from the market plunge. We are no longer in an era in which market movements unfold in a reasonable amount of time. Even in the 1980s, before computerized trading and online brokerages, it was easy to panic and sell. Today, however, you barely have a chance to actually sell before the moment has passed and the market has recovered.
This is a monumentally important lesson. Now, more than ever, you must keep emotions in check. You may have very little time to respond to market moves, especially downdrafts. If you are unable to keep a clear head, all your hard work investing your money could fly right out the window.
Defense in a Market Correction
That leads to the second lesson, which is something I am reiterating from last week, when I gave you a “crash protocol” to follow when things get insane and the market starts to tank.
The single biggest defensive weapon you have against a market crash is to be invested in a long-term, broadly diversified portfolio. You must understand how critical each of these two elements is when it comes to market crashes, especially that they can now occur in the blink of an eye.
You must invest for the long term. It’s OK to devote some of your capital to trading, but take note that the only 10-year periods where investors lost money in stocks was 1927 to 1937 and 1928 to 1938. The average amount lost was only 1%. That includes dividends being reinvested. If you are in it for the long term, you can literally ignore corrections because they will smooth out over time.
Diversification is the other piece that’s important. When I say “broadly diversified,” I mean across all asset classes. Small, medium and large-cap stocks. Growth and value. Domestic, international and emerging market. Real estate. Bonds of all maturities. Preferred stock, exchange-traded debt, high yield investments, alternative investments, commodities and even a little bit of precious metal.
Quality Stocks Bounce Back
The next lesson is that when the market recovers, the first things that will pop back up again are the quality names of that era. What came back first this time? The Walt Disney Co. (NYSE: DIS), Apple (NASDAQ: AAPL), Amazon.com (NASDAQ: AMZN), Realty Income (NYSE: O), Visa (NYSE: V), MasterCard (NYSE: MA) and energy.
These should always be on your shopping list. Pick those top names in each category and cast your lot with them.
Safety in Stop Losses
The next big lesson is to use stop-loss orders. If you have recently opened a position in a stock, I suggest setting a 7%-8% stop-loss order. It prevents you from making a bad call, should a stock suddenly tank for some reason that you didn’t foresee. It also stops you from losing a lot of money if you open a new position and a correction hits.
This also applies to opening short positions during a correction. We saw things turn around very quickly. If you did go short, you don’t want to get hammered if the market scores a big recovery.
How to sleep easy at night
Is the economy keeping you up night? Do you worry there’s another crash just around the corner? If so, you can stop worrying right now. All it takes is a few minutes. Find out how right here.