Humans aren't designed to be successful investors. When things are going well, our brains lull us into complacency, causing us to drop our guard against latent threats in the market. Then, when things take a turn for the worse, our brain tells us to stampede toward the exits. Put these two together and you have a recipe for disaster.
So, how can individual investors like you and I survive in the stock market? We asked three of our analysts to chime in, and here's what they had to say:
Todd Campbell: Keep cash on hand and avoid leveraging
Let's face it, when it comes to brass tacks we're all going to get a little antsy when the market tumbles. It's only natural. But just because we're bound to get anxious when stocks dip doesn't mean that we can't take action now to keep that anxiety from causing us to make rash, unprofitable decisions.
One of the best ways to keep a clear head when markets are struggling is to keep plenty of cash available and to limit the amount of margin you use. By having money set aside that can be used in a pinch, there's less of a need to liquidate at unfavorable prices. And if you're avoiding margin, you won't have to worry about your broker calling you out of the blue to tell you that you need to come up with money for a margin call.
Thinking ahead and keeping some cash in the wings has an additional benefit, too. Because you're not fully invested, you can use some of that extra cash to buy top stocks when they drop. That shifts your mindset from being reactive to proactive and that in itself could be enough to keep you from wrecking your portfolio.
Dan Caplinger: Have a watch list and ideal price list
One of the most gut-wrenching decisions investors have to make is when to buy and sell. When the market is plunging, you know that you ought to take advantage of bargain-basement prices to buy your favorite stocks. But whatever caused the particular crisis of the day can make it almost impossible to pull the trigger.
The best way to keep that emotional response for sabotaging your best investing opportunities is to plan for it in advance. By maintaining a watch list of interesting stocks, you can essentially set up a shopping cart if those share prices reach the levels you want to see. If you combine that group of favorite companies with a wish list of ideal prices you'd like to pay, then you can cut emotions completely out of the equation.
Having a watch list isn't a surefire way to get rid of emotion entirely. But it can nevertheless go a long way toward making bargain-buying more automatic and less agonizing.
Brian Stoffel: Keep an investing journal
Keeping an investing journal has been a lifesaver for me. In essence, all that I'm really doing is writing down exactly why I'm buying a stock before I buy it, and what would have to happen for me to sell it. Just as importantly, when it's time for me to sell a stock, I write down exactly what my thinking is.
This act alone helps my mind stay focused on what matters: a long-term time horizon. When I'm forced to write down why I want to do something, I'm able to see when short-term-ism has me acting out of fear or greed, instead of making sound financial decisions.
By the same token, once a year, I will review my journal. By doing so, I can measure how well my decisions played out, and get a better idea for what type of investor I am. If I'm continually writing about how volatility stresses me out, then I know I'd be better suited to stick with safer, less volatile investments.