How To Respond To Broad Stock Market Drops

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I’m not an investing expert but I think I am a relatively seasoned amateur investor in that I’ve seen a lot of things and can draw up conclusions based on that experience (of an amateur investor) that may be helpful for anyone who is searching for what to do after a drop like yesterday. The largest drop since the day after the NYSE opened after 9/11/2001 occurred yesterday in which every major American stock index fell and so you may be wondering what it is you, amateur investor, should do. If the markets recover from yesterday, it won’t be such a bad thing to have a little bit of a correction, but if this is a slide that indicates the start of a recession, Greenspan made comments about a recession over the weekend which didn’t help matters; this may be an excellent buying opportunity.

1. Don’t sell anything (yet).
Don’t let emotions cloud your judgement, let this all shake out before making any decisions one way or another. I haven’t touched any of my funds because I want to wait to see how things play out before making any decisions. If you own individual stocks, their fundamentals haven’t changed (the market’s realization of broad market fundmentals haven’t really changed either, it’s just some panic, profit taking, and other activity going on trying to take advantage of the situation) so don’t go into massive sell-off mode. The market could rebound or it could tank, you can’t reliably guess which way so you might as well not guess.

2. Analyze your asset allocation
If you don’t like doing nothing, consider looking at your allocations. Since stocks took a hit and bonds rose, you may want to take a look at your asset allocation and perhaps readjust in the coming weeks as things shake out. This may have been a wakeup call that your allocation is stock heavy; did the big drop give you the shakes? Maybe you have too much for how much risk you can handle.

3. Load up on discount stocks
If you liked a stock on Monday, you probably like it more now because it’s much cheaper. Every stock I own fell yesterday and if I had a spare nickel in my Roth IRA, I would’ve bought some more of the stocks I held because there was a sale yesterday! (see that silver lining?) Take Disney for example, a stock I own that has been a high flier, you may have wanted to buy some but thought that the 30% runup the last year or so made it too pricey for you. Well, yesterday Mr. Market declared a 1 day sale of nearly 4% off on shares of Disney – go buy some!

4. Consider putting in a little more into that 401K
Are you contributing the minimum into your 401K? Consider loading up a few more percentage points and getting your money into the market after a discount and then ratcheting it back a little bit after the market recovers. It does smell a little like micromanaging your 401K, I agree, but if you can spare a few bucks it’s certainly a better time (than two days ago) to give your 401K a tiny boost when you know your dollars will go farther.

None of this is financial advice, it’s just the thoughts of a 26 year old amateur investor who has experienced a few market falls, this one hardly even registers when you compared it to the doozy felt in 2001 (tech bubble, 9/11). Anyone else have any helpful tips on how to react? I’d be particular interested to hear from folks who have been investing longer than I have and have seen bigger corrections in both the stock market and other markets.

{ 12 comments, please add your thoughts now! }

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12 Responses to “How To Respond To Broad Stock Market Drops”

  1. I think that the best reaction after a ONE DAY drop like yesterday’s is no reaction. If you had some money sitting on the sidelines waiting for an opportunity, and your research indicates that a good strike price was met yesterday, maybe buy some more. But, as you say, one day is not a leading indicator as to whether or not this is the start of a major market downturn or a minor blip on the “correction” screen.

    My personal effects were one win and one loss. I sold JKI and WB to take some profits last week – and because I am moving some assets to Zecco. So, even though I thought I was losing some money making opportunities during the funds transfer, as it works out, I did well. The $4,000 that I started with yesterday morning is still worth $4,000 – which is better than a lot of folks did – and a lot better than I would have done had I still owned JKI and WB!

    On the other hand, my employer sent my 403b contribution to Fidelity in time for me to buy into the market on Monday! Oh well…

  2. TT says:

    I recommend that everyone in the market read the writings of Kenneth Fisher. From his monthly column in Forbes, to his books, the newest book being THE ONLY 3 QUESTIONS. He shows that bear markets dont start with big drops. They start very slowly, keeping everyone invested until they sell at the bottom. So yesterday’s drop was probably just a correction, and should not be sold into.

  3. Tinyhands says:

    Naturally a lot of bloggers are discussing this, so forgive me for repeating what I’ve said elsewhere. Plenty of research indicates that if an investor sat out the 10 best days of the market over a 10 year period he would miss out on nearly 5% average annual return. Do you know which are the 10 best days in any 10 year period? I sure don’t. Get invested and stay invested.

  4. Jeremy says:

    People also need to remember that a 3-4% drop is almost nothing when compared to what the market has done over the past three or four years. I think people get too caught up with the media’s gloom and doom and completely ignore the fact that they may have made 30-40% over the past few years yet freak out when they lose just a couple percentage points in a short amount of time.

    It is something to keep an eye on, as I think this “correction” will last a while. Might not be a bear market, but I don’t see the market recovering to where it was a few days ago in any short amount of time.

  5. Tim says:

    You should always have a rolling stop limit order to protect your assets. You should ensure that the stop limit order isn’t going to take effect for every minor downturn, though. This way, if the market starts tanking, you will have made what you thought was good and can repurchase the stock at lower price when you think it is back on the upswing. You’ll have to figure out the percentage formula that works for you, maybe around 10% drop is the trigger for a stop limit order. Higher % if it is a highly volatile stock.

  6. Jano says:

    Very interesting. I agree with putting trailing stops, thats very important. I also feel like if you swing trade or trade actively you can reduce losses. of course i dont recommend this to a novice investor. sometimes staying OUT of the market is the most profitable thing you can do. I pose a question to you all, which is also posted on my own blog site do you think what we saw yesterday was the begining of a recession or just a small correction?

  7. Greg R says:

    “tips on how to react…”? Don’t react at all. Consider acting by dollar cost averaging into the slide, putting away a little bit more than you would normally, if you can. This is an enhanced form of dollar cost averaging called “value cost averaging.” It goes against our instincts to buy into a declining market, and this technique is not for the faint-of-heart. But the logic is sound. Think of it as a short-term strategy for the long-term investor.

  8. Matt says:

    To sell now would be an ideal example of the worst possible market timing behavior. You want, where you can, to sell HIGH and buy LOW, not the other way ’round.

    Now isn’t the time to panic…now is the time to pick up bargains. 🙂

  9. RonenV says:

    Buy and hold, friends. There is an extensive body of research that proves that your best shot at under-performing the market is to buy and sell stocks. The market goes up, the market goes down – the important thing is your expected return over the long term. The LONG term. Ignore short term price swings.

    Tim’s suggestion that you should keep a rolling stop limit on your investments is bad strategy. Automatic trade execution of this nature may create a substantial tax liability for you – especially if the asset you are selling has appreciated substantially since you bought it. If you are going to trade, do it because you decided to do so, not because of random stock price variability.

  10. plonkee says:

    I’m with the do nothing brigade. Whenever and however you would normally look for a good buy, do so. In the long run it doesn’t really matter.

    By complete coincidence however, I had a small tax windfall come my way yesterday (ÂŁ200) which I invested this morning in my index fund (FTSE tracker).

  11. Star Money Articles for the Week of Feb. 26

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  12. Tim says:

    I didn’t do anything either, considering I had a mixed bag of both positive and negative stocks and in spite of my index funds getting hammered. Overall, the picture wasn’t so bad and the gains the past two days have been good. I’ll say that stop limit orders can be used and should be used by novices as well.

    RonenV, a stop limit order is not some random number drawn out of a vacuum. Again, it is based off of what you have decided is an adequate stock price to sell and should be based off of what your buying stragety was for the stock in the first place. Nothing more, nothing less. Hopefully, you’ve decided what is a good price to sell a stock already. If you haven’t you should be doing an evaluation at least annually on selling and buying. Buying stocks is for the long term, but you should have a target sell price in mind when you buy a stock in the first place. I want to reiterate that a stop limit price should be beyond these minor market fluctuations so it does not trigger on such small up and down swings and it should be updated according to stock increases or decreases. Despite the tax liability, having a simple safety net is much better than losing substantial portions of your savings.

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