Most of you reading this will know that the stock market underwent a rather significant correction for just over three months, from late September to the end of December 2018. Why was it significant? Since the late 2000’s, corrections of this magnitude have been few and far between when compared to the norm. Here are some rather interesting facts about stock market corrections that I won’t elaborate upon, other than to state that they are entirely normal and thus to be expected if you plan to be a serious investor.
You might notice that I haven’t posted anything since just around the start of that correction and looking back, the last post ironically had some interesting insights to consider whenever the market ‘goes on sale.’ But soon after that post, as the skies clouded over and brewed into the market storm which it became, I – like most long-term investors – went into my investing ‘storm bunker’ to wait out the storm, doing little to nothing except try my best to ignore all the bad news.
The hunkering down also means that I typically don’t write anything; in fact, I usually dig into the great insights provided by the likes of The Motley Fool long-term gurus in order to re-assure me that the course I’m on is the correct one and especially so that I don’t make any stupid mistakes during such a time.
Of course, this mindset runs completely contradictory to the Wall Street mentality of trying to trade every blip and dip, to cut both losses and gains very short, etc.
So who’s right? Wall Street (and their entirely short-term mentality) or investors like me who’ve developed a long-term mentality?
Before I answer that, here’s what I did and didn’t do both during and after this recent correction.
What to do? Research.
I find that, during a strong market correction, it’s best to focus on good news instead of bad news. As some of your best-performing holdings take hits of 20, 30, and even 40+ percent, it’s a great time to seriously consider why you bought the stocks of those companies in the first place. Read about what some of them are up to. Is it emotion that’s dragging a price down or is there something now seriously flawed about that company’s fundamentals that the correction has exposed?
In nearly all cases, emotion rules the day, entirely the short-term investors including Wall Street that are selling and driving the prices down. The companies in question are still mostly going about business and few, if any, have had to shutter their doors (and any wise investor would not be putting money into an obviously failing enterprise, anyhow). So your research should be about sorting emotion from fact; that is, finding which companies on your radar have strong enough fundamentals to weather the storm and bounce back quickly after the storm clears and the market begins its rebound.
Here’s perhaps the most important thing to remember (as stated elsewhere in this blog and by other long-term investors): You haven’t actually lost anything until you sell! Until you place that sell order or click that sell button, your losses are only theoretical. So unless you absolutely must sell during a downturn, hold on at all costs and wait for the rebound! Especially if the company was doing well going into the downturn.
What NOT to do? A bunch of trading.
One of the hugest temptations during the emotional roller-coaster-from-hell that a big market correction throws your way is the temptation to sell once your holdings start to plunge. It’s also very tempting to buy back in when there’s a day or two, or maybe even more, of an uptrend.
If I had given into fearful emotions during the recent correction, I would have been kicking myself now instead of being grateful that I did no trading. Are there some stocks on my radar that I wish I would have had the guts to buy while things were really stormy? Absolutely, as most of them have shot up considerably since. But buying while the storm is still around is still not the best thing to do. The bunker is still your safest place to be.
What to do after? Wait for a time and then ACT
What I’m about to write runs contrary to those who think you need to buy while there’s still “blood in the streets.” Instead of buying stocks that look ridiculously cheap right in the midst of a downturn or correction, I like to find evidence that the storm has officially passed before scooping up bargains. My reasoning is this: a cheaper stock might get cheaper still, which means trying to buy at a low price while a downturn is still happening is like trying to catch a falling knife. How much lower does it have the potential to go?
Instead, I look for overall upbeat news on the markets. Once this translates into a sustained market uptrend of at least a week or two – including the prices of stocks on my radar coming off their lows – and a general sentiment that the correction is over, then I spring into action. I no longer fear that I’ll be trying to catch a falling knife.
If I have a cash reserve, then I make a purchase or two based upon what my research revealed. If I have no cash, then I look to free up some cash by selling the stock of any companies that have had an overall weakness going into the correction and coming out of it.
In other words, once I free up cash, I’m looking for one or two companies that will help me to build an investing cushion faster than maybe one or two of the existing companies that I hold.
(This idea of a cushion is very important. Although only a few of my stocks flirted with the prices I had bought them at, mainly ones that I owned for less than a couple of years, my overall portfolio return at the depth of this correction was still quite strong.)
So who’s right?
As promised, here’s my answer as to who’s right: short-term traders (mindset of Wall Street) or long-term traders like me (mindset of The Motley Fool, Peter Lynch, Warren Buffett, etc.)?
Here’s how I see things: Wall Street investing firms caters to their clients, people who don’t do market research and therefore do not understand that the nature of the stock market is to undergo gyrations, sometimes violent. I for one have likened the market to having the same behavior as the oceans and the weather many times – although very unnerving and totally unpredictable, they are completely natural. However, these people have become clients because they don’t want to have to learn about and research stocks and market trends. That’s why they pay these firms – these people don’t want to spend the time and effort to do this on their own, much like how I’d rather pay a mechanic to fix my car than figure out everything myself.
Therefore, they get panicked by every little dip in the market, like those very typical days when the market will lose one percent or more in value. And then when the market goes for a day or a few days of an upswing, they’re equally as panicked about getting into new investments before they ‘miss out’ on more gains.
Is it any wonder why the big investing firms of Wall Street are so schizophrenic? They have no choice but to adopt a short-term mindset! They get paid by their short-term minded clients and so they have to be short-term minded themselves! Again, this is how I see things on Wall Street; feel free to comment if you have any better insight.
Anyhow, the portfolio returns of the likes of Peter Lynch, Warren Buffett, Jack Bogle, and even non-institutional investors like me are proof that the long-term mindset is the clear winner.
The Final Word
The next time a market correction comes around, it’s best to be an inactive trader: do research and don’t trade. It’s also always best to have some cash on hand to buy stocks at a cheap price once the correction appears to have ended.
As of this writing, there are rumblings of another big correction and further market declines. I can’t recall a time when there hasn’t been news like this! The point: there’s no perfect time to buy a stock.
In the meantime, a strong market upswing like this one over the past couple of months is a great way to once again build an investing cushion so that when – not if – another dip or downturn or major correction (or crash) comes along, you’ll likely emerge still substantially ahead like you were before the storm.
One last thing: be sure to click the Follow button near the top of this page. Also, if you’re a brand-new stock investor – or still thinking about it – then I highly recommend starting with my 5-part Stock Starter Series. To new beginnings!