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How to Stay Sane in a Crazy Market

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Falling markets are hard to endure. But markets like we're seeing right now, where stocks seem to drop sharply one day only to rebound strongly the next, can be even more frustrating. In order to survive the ups and downs, you have to do two things: develop your own view of where the economy and the financial markets are going, and stick with it even when the market seems to be telling you that you're wrong.

On again, off again
On a day like yesterday, on which the Dow jumped 275 points to vault back over the 10,000 level yet again, everyone seemed to focus on the good news in the market. State Street's (NYSE: STT  ) pre-market announcement yesterday guiding its second-quarter earnings estimates higher seemed to cause hopeful investors to infer that the coming earnings season would be more positive overall. Despite fears that a bank tax could weaken financial stocks, JPMorgan Chase (NYSE: JPM  ) and Bank of America (NYSE: BAC  ) rose strongly in line with the broader market.

Yet in the topsy-turvy world, a single day's gains can turn around on a dime. Only a week ago, the Dow fell below 10,000 as investors seemed focused on international concerns. Fears that China's strong growth might fall off in the future sent stocks reeling, with Alcoa (NYSE: AA  ) and Titanium Metals (NYSE: TIE  ) feeling the direct impact of potentially lower demand for commodities. European labor strikes also darkened the mood, and traders ignored positive news on the housing front.

Of course, the net effect of those two days turned out to be just about nothing; yesterday's rise canceled out last week's drop. But if you paid too much attention to the news of the day, you might feel like you've been stuck on an emotional roller-coaster ride.

Staying the course
To get off that roller coaster, you need your own hypothesis about the big picture for the economy and the impact it's having on companies. New economic data comes in every day, and as earnings season ramps up, you'll get constant feedback about how businesses are adapting to changing economic conditions. But while traders throughout the market often respond in kneejerk reaction to a single piece of new information, the advantage you have is that you don't have to.

In fact, the market's irrational weaving back and forth gives you constant opportunities, if you have the strength of conviction to follow through on your beliefs in the face of contrary information. You can use what seems like short-term bad news as a chance to get a cheap entry point for a stock you believe is a promising long-term play. For instance, Disney (NYSE: DIS  ) announced late yesterday that it lost a $270 million jury verdict relating to royalties allegedly owed to "Who Wants to Be a Millionaire" creator Celador International. But even though that may push shares down, if you think Disney's long-term prospects are sound, then the discount is exactly what you're looking for.

Of course, if you start seeing a lot of news that runs counter to your beliefs, then you need to reevaluate. You want your hypothesis to be firm and well-supported, but being stubborn when things go against you will just cost you money.

Know yourself
You may find, however, that you simply can't roll with all the punches you get on a daily basis. That doesn't mean you can't be a good investor. It just means you need to use a slightly different strategy.

If all the noise distracts you from investing for the long term, then turn it off. Focus solely on the stocks you own and the fundamentals of those companies. That way, you won't let a brief setback pull you out of a great stock.

Here's an example: Back in May, two analysts downgraded Netflix (Nasdaq: NFLX  ) , arguing that shares were overvalued and due for a pause. Yet if seeing that item would have made you sell your shares, you would have missed the stock's 15% move up since then. Often, you'll do much better simply ignoring day-to-day ramblings and focusing instead on a company's long-term business prospects.

The path to success
Wildly swinging markets are tough for investors. But they also present great opportunities. If you can keep an even keel and build a strategy you can stick with, you'll be able to turn those ups and downs to your advantage.

Even with the stock market down in 2010, there's still hope. Alex Dumortier shows you how to salvage your portfolio with three stocks and three ETFs.

Fool contributor Dan Caplinger has trouble staying sane in all this heat. He doesn't own shares of the companies mentioned. Walt Disney is a Motley Fool Inside Value selection. Walt Disney, Netflix, and Titanium Metals are Motley Fool Stock Advisor picks. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy flew over the cuckoo's nest.

Read/Post Comments (2) | Recommend This Article (9)

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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 July 08, 2010, at 12:15 PM, kurtdabear wrote:

    I don't think that learning that DIS has cheated people it does business with out of hundreds of millions of dollars represents an "entry point" as much as a warning. If a company is this greedy and dishonest with contractors and suppliers, it would not hesitate to screw-over shareholders when it's in management's best interests to do so.

  • Report this Comment On July 08, 2010, at 5:15 PM, DDHv wrote:

    We concentrate on company quality. However: when it looks like a company might be worth buying, it gets a limit bid near the two-year low. Each week the bid is raised closer to the current price, after re-evaluation of the company quality. For sales, except covered calls, the start is near the two year high, and the change is downward. This is adjusted per company quality, even to taking a company off the list, or starting close to the current price.

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