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Are You an Intelligent Investor?

If you're staring down losses and worried for your savings, then you need to know what to do next. But before we can get to that, you need to answer yourself this: Are you an intelligent investor?

If you're not, sell your stocks and flee to index funds ASAP. If you are, then current conditions offer the profitable opportunity for a very different course of action.

So, are you an intelligent investor?

Let's reverse-engineer this one for a moment
According to the folks at the respected Muhlenkamp (MUHLX) fund, general intelligence and investing intelligence are two different beasts. While the opposite of the general intelligence is ignorance, the opposite of investing intelligence is ... emotion.

As Executive Vice President Tony Muhlenkamp put it when I spoke to him recently, "What we try to do here is intelligent investing ... [our] job is to take advantage of the people who behave emotionally."

Believe it or not, emotional decision-makers compose an enormous portion of the market.

Up, down, whee!
Remember Wednesday, Jan. 23, 2008? It's OK if you don't -- it was a market day like a lot of others we've had recently ... meaning it produced wild price swings.

The Dow -- the index of 30 mega-cap heavyweights, including JPMorgan Chase (NYSE: JPM  ) , Johnson & Johnson (NYSE: JNJ  ) , Microsoft (Nasdaq: MSFT  ) , and Intel (Nasdaq: INTC  ) -- went down more than 400 points on the day before bottoming at 11,530. Where did it end the day? At 12,270 -- up more than 700 points from the low!

Small-cap investors -- like those of us who run Motley Fool Hidden Gems -- endured a similarly wilder ride. The Russell 2000 was down 2.5% by 12:50 pm before closing the day up 3.1%. That's a 5.6-percentage-point swing! Individual small caps, including Netflix (Nasdaq: NFLX  ) , J. Crew Group (NYSE: JCG  ) , and Foundry Networks (Nasdaq: FDRY  ) , offered even more harrowing rides (albeit with happy endings).

An amusing timeline of the aforementioned events
Jim Gillies, my Foolish amigo at Hidden Gems, rightly summarized Wall Street's schedule that day as follows:

10:00 a.m.: Sell.
11:00 a.m.: Sell!
12:50 p.m.: [Quick lunch.]
1:00 p.m.: Buy.
3:00 p.m.: Buy!

Now tell me emotion does not govern the stock market on a day-to-day basis.

Pay attention: This is where you come in
So what were you doing when Wall Street was ready to "sell everything now"? If you weren't preparing to buy, then you weren't ready to take advantage of the emotional money on the market. Furthermore, if you waited until 3:30 p.m. to buy a stock, you, too, fell victim to the stock market's emotion-driven hype machine.

Of course, that is the greatest challenge facing investors: to have the courage to buy at low valuations when no one else will. If you can do that and conquer your emotion in the process, you will be a successful long-term investor.

Be an intelligent investor
Eliminate emotion from your financial decision-making and use the current down market to position your portfolio to profit. That's what we're doing at Hidden Gems anyway. Because while the prices of some of our favorite small caps have in some cases changed drastically (for the worse) these past few weeks, their fundamentals and long-term potential have not.

We reviewed in detail our 10 top picks for new money now in the most recent issue. If you'd like to read about them, as well as have access to all our research and recommendations, we offer a free 30-day trial to the service. There is no obligation to subscribe.

Tim Hanson owns shares of Muhlenkamp but of no other securities mentioned. Johnson & Johnson and JPMorgan Chase are Motley Fool Income Investor recommendations. Microsoft and Intel are Inside Value picks. Netflix is a Stock Advisor selection. Muhlenkamp is a Champion Funds recommendation. The Fool's disclosure policy is not emotional, though it did tear up at the end of Where the Red Fern Grows.

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