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2 Key Rules for This Crazy Market

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Back on Oct. 10, in the midst of the Great Market Freefall of 2008, I wrote an article that encouraged readers to stop and think, to take a moment to acquire a little perspective before frantically dumping their stock portfolios.

It was one of several I wrote during those weeks that pointed at an idea I started calling "Rule 1": Don't panic. Panic is expensive.

It's an important rule, maybe the most important rule for successful stock investing after buy low and sell high. Know your investments, do your research, and don't buy a dead cat bounce all have their place, but panic is a portfolio-killer.

Don't be that guy
Panicked people buy good stocks high (like Vale (NYSE: RIO  ) at $40) because they're afraid of missing the boat, and sell them low (like First Solar (Nasdaq: FSLR  ) at $90) to cut their losses. Panic-prone people jump on trends too late and buy "hot tips" from some guy their Uncle Charlie met in a bar, all without doing any research. And when they do do something that's arguably right, like buying big-name stocks like Research In Motion (Nasdaq: RIMM  ) at $50, they screw it up by selling -- yep, in a panic -- when it hits $43 a couple weeks later.

Panicked investors, in other words, are those who react to events -- specifically, to their emotions about events -- instead of following a plan. They're the essence of the stereotypical "retail investors" that Wall Street brokers claim can't manage their own money.

As with all stereotypes, there's some truth to be found in that one. And in times of crisis, even those of us who are normally pretty sensible can make some big mistakes.

But if you can just remember to follow Rules 1 and 2 before making any trades, you'll come through this crisis in much better shape.

Wait. What's Rule 2?
Rule 2 is so named because it's what you do right after you catch yourself and remember Rule 1, and that is: Follow your plan.

Your plan in any given moment might be as simple as "Buy another 200 shares of Baxter International (NYSE: BAX  ) if it goes below $50 again." Or it might involve deciding when to sell parts of several positions to reallocate 15% of your portfolio to a bond index fund. It might be a momentary thing -- "If Microsoft (Nasdaq: MSFT  ) goes back below $20 before lunch, I'm buying some; otherwise, I'll wait until next week and take another look" -- or it might be a complex asset allocation strategy you intend to carefully unfold over the next several decades.

If you're really good at this investing thing, you have all sorts of plans. And you stick to them, because you know that investment decisions made with your rational mind, not your heart or gut, have the best chance of success.

Okay. So, how do I get a plan?
Ideally, your plan will start at a high level and work down, somewhat like this:

  • What's your goal? How much money are you hoping to have, and when are you hoping to have it? Are you saving for retirement in 40 years, or hoping for a new boat in five?
  • What is the appropriate investing strategy to achieve the goal? This depends on the amount of money you'll need, when you'll need it, and the seriousness of the goal. Retirement investing is a big deal -- you're going to live on that money -- and it requires years of investing, a well-thought-out asset allocation strategy, and so on. Something less serious might be, "I'm going to take my bonus and buy Marvel Entertainment (NYSE: MVL  ) stock. If it does well, I'll buy a new boat in a few years." But note that even then, there should be a plan -- an idea, based on your ongoing research, of what "doing well" means for Marvel (so you know what to expect and when to sell), some thinking around the boat you want to buy, some buy-in on this whole boat thing from your spouse, and so on.
  • What are the steps I need to take now? Do you need growth stock ideas? A corporate bond fund? Tax advice? Whatever it is, do that -- no matter what the market is or isn't doing today.
  • If you need to rethink your plan, rethink your plan. Don't chuck it all overboard in a panicked flash because Dell (Nasdaq: DELL  ) turned in a better quarter than expected, or even because Henry Paulson decided to nationalize your neighborhood deli. Take a deep breath, remember Rule 1, and let your brain take charge.

Whether you're looking for asset allocation guidance, help choosing the best options in your 401(k), strategies for getting through the downturn, or just some reassurance that you're doing the right things, the Fool's Rule Your Retirement newsletter service is an excellent resource for retirement investing in challenging times. A free trial gives you full access for 30 days, with no obligation.

Fool contributor John Rosevear isn't kidding about getting your spouse to buy in on the boat thing, y'all. He has no position in the companies mentioned, and no boat at the moment, though he remains hopeful. Microsoft and Dell are Motley Fool Inside Value picks. Marvel Entertainment is a Motley Fool Stock Advisor recommendation. Try any of our Foolish newsletters free for 30 days. The Fool's disclosure policy always promises smooth sailing.

Read/Post Comments (6) | Recommend This Article (19)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 27, 2008, at 3:14 AM, Daretoth wrote:

    I agree with you, but the market seems to rise and fall based on purely emotion and not rationale. Otherwise GM and F and C would have gone to zero, but the hope of government intervention is enough to make them rise.

    Again, long term your strategy is great and makes a great deal of sense. Short term...the market doesn't make any sense.

  • Report this Comment On November 27, 2008, at 6:16 AM, TMFMarlowe wrote:

    Daretoth, thanks for stopping by. I agree, the market isn't making any sense short term. I think I may need to propose a Rule 3: Forget Mr. Market's crazy antics, just buy intrinsic value and be patient. Maybe I'll do that tomorrow morning.

    Meanwhile, happy Thanksgiving!

    John Rosevear

  • Report this Comment On November 27, 2008, at 11:23 PM, dividendgrowth wrote:

    Well, TMF is highly against cutting any losses. They want you to hold forever!

  • Report this Comment On November 28, 2008, at 7:09 AM, TMFMarlowe wrote:

    I don't want you to hold forever! I'm very much opposed to the whole hold-it-until-it-comes-back mindset unless an objective analysis supports it. I've been arguing for weeks that people who want to hold stocks should be taking advantage of the broad decline to sell what they have and buy the best investments they can find in light of where the economy is likely to go over the next year or two.

    If you wouldn't buy it at current prices, I absolutely recommend that you sell it and buy something else! But at the same time, don't dump your current investments until and unless you have a good, rational-mind reason to do so.

    John Rosevear

  • Report this Comment On November 28, 2008, at 3:00 PM, k2dfz wrote:

    I totally agree with TMFMarlowe - Have re- examined all my holdings and am convinced that they should be held long enough to see if they are going to behave in an upward direction as most of them did on Nov.26. If not, they will be under consideration for removal! Am ready to buy MVL & NFLX & also increase my AAPL shares.


  • Report this Comment On December 03, 2008, at 12:34 AM, timk80 wrote:

    You mentioned RIMM in your article, they just hit a 52-week low. I really like the way their business is moving especially with their large revenue growth. Is it rational to buy now based on that premise or should I be looking for other information and potentially a lower price?

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