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Don't Freak Out About One-Day Drops

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Yesterday's market action took a lot of investors by surprise. But if it actually changed your mind about your long-term investing strategy, then you have some work to do in order to build a more disciplined approach to your portfolio.

Reversal of fortune
Until yesterday, investors thought they had the markets pretty much figured out. Stocks, gold, and even bonds all found ways to rally, while the U.S. dollar was stuck in a downward spiral.

But yesterday, a couple of those paradigms came unraveled. Apple (Nasdaq: AAPL  ) proved that even when you have an amazingly successful quarter, a soaring stock price can come falling back to earth if that success comes for the wrong reasons.

Meanwhile, on the dollar front, two things happened that were unexpected. China made a token quarter-point increase of its interest rates, its first in three years, signaling its desire to rein in red-hot growth in the world's second largest economy. More surprisingly, Treasury Secretary Tim Geithner reiterated his commitment not to devalue the dollar against foreign currencies, which sparked a huge bounce for the greenback.

In response, just about everything that had gone up in recent months went down. Commodity-related stocks Titanium Metals (NYSE: TIE  ) , Yamana Gold (NYSE: AUY  ) , and Hecla Mining (NYSE: HL  ) dropped between 5% and 8% as fears of a slowing Chinese economy rocked future prospects for demand for metals. Gold and silver bullion fell 3% and 4%, respectively, as a possible peaceful resolution to currency wars started to emerge. And emerging market plays MSCI Brazil (NYSE: EWZ  ) and Vanguard Emerging Market Stock ETF (NYSE: VWO  ) , which hold a number of commodity-heavy stocks in their portfolios, both saw 3% drops as well.

It might seem like the rules of investing just changed. But if that's what you think, then you're taking such a short-term perspective that you're going to get whipsawed back and forth over and over again.

Seeing the forest for the trees
The past two months notwithstanding, markets rarely move in a straight line. It's important to keep some perspective on market moves, or else they'll tempt you into an emotional response that will take you out of your best long-term investment ideas at the worst possible time.

For instance, take Apple. Even after yesterday's $8.50 drop, the stock still closed at its third-highest price ever. And although some were concerned about lower-than-hoped-for iPad sales, the bigger-picture takeaway is that Apple has continued to blow past even the rosiest of expectations and still has a commanding lead over struggling competitor Research In Motion (Nasdaq: RIMM  ) .

It's true that many investors credit China for being largely responsible for the run-up in commodities prices recently. After all, China's appetite for companies with commodities exposure is well documented and hasn't seemed to slow much, even as energy and metals prices have risen sharply from their 2009 lows.

But although symbolic gestures like a small move in interest rates can have huge psychological impact on traders, they don't change the fundamental picture for China as one of the world's fastest-growing economies. If anything, reasserting control of an economy some saw as potentially overheating makes the long-term bullish case for China even stronger. Avoiding a Chinese asset bubble makes more sustainable long-term growth easier to achieve.

How to respond to one-day moves
Days like yesterday make it clear that you really need to know what the overarching rationale behind your investment strategy is. Even better, if you put that rationale in writing, you'll be able to refer to it every time the market broad-sides you with a big move against you.

In the end, whatever helps you avoid an emotional kneejerk reaction to the day's news can save you from getting pulled back and forth as market crosscurrents take turns moving stock prices up and down. It's true that every long-term trend tops out on a single day, but far more often, pullbacks merely end up being a pause in a continuation of that trend. Letting market whipsaws pull you out of smart investments is one of the biggest mistakes you can make with your portfolio.

Forget about the day's ups or downs. Click here to get The Motley Fool's free report, 3 ETFs Set to Soar During the Recovery.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool contributor Dan Caplinger  finds both the ups and the downs of markets fascinating. He owns shares of Apple and Vanguard Emerging Markets Stock ETF. Apple and Titanium Metals are Motley Fool Stock Advisor selections. The Fool owns shares of Apple and Vanguard Emerging Markets Stock ETF. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy lives at the Freak House. 


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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 October 20, 2010, at 2:07 PM, silverminer wrote:

    Great piece, Dan! A valuable reminder for all. :)

  • Report this Comment On October 20, 2010, at 9:01 PM, xetn wrote:

    " More surprisingly, Treasury Secretary Tim Geithner reiterated his commitment not to devalue the dollar against foreign currencies, which sparked a huge bounce for the greenback." You obviously missed the Fed's pronouncements about QE2, a PC version of creating massive amounts of new currency units out of thin air. What do you suppose will be the result of that action on the purchasing power of the new money?

    With a Fed strategy focused on more money creation, it won't matter what Timmy G' policy is. The dollar will continue its race to the bottom.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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