Should You Pounce on Panic-Sold Stocks?

We've told you not to panic. But for many investors, it's too late -- they already did.

If you think professional investors are scared -- and they are -- just look at average folks watching their 401(k)s go up in smoke. From looking at money flows in and out of ordinary mutual funds, there's a lot of fear among individual investors. And although up-to-the-minute figures for fund purchases and redemptions aren't available, the news thus far is disturbing:

• Stock-fund investors took out $19.5 billion in August, following a $27.4 billion outflow in July.
• Investors pulled $24 billion from emerging-market funds during the third quarter.
• Just last week, fund shareholders cashed out a record $65 billion from their mutual funds, two-thirds of which came from stock funds.
• Bond funds have also seen big redemptions, with losses of $28.5 billion for October as of last Friday.

In light of Monday's huge recovery, all of that selling last week is terrible news -- although the future could easily prove panic-sellers correct if that big jump proves to be just a temporary relief from further declines.

Nevertheless, if you still believe the stock market is a good place to invest, then all of that panic-selling is good news for you. It's making share prices cheap, and especially since mutual funds tend to hold huge numbers of securities, the selling pressure that results from shareholder redemptions typically forces funds to dump lots of stock onto the market. That spells opportunity for bottom-fishing investors with cash to spend.

Shooting fish in a barrel
Amid all of the selling, some savvy buyers got in on the action on Friday and bought shares of companies that were getting beaten down. One way you can gauge buyer interest is to look at money flows -- the size of trades that occur after incremental share-price rises, also known as upticks, versus trades following incremental price drops, or downticks. By tracking all of the individual trades throughout the day, you can see where investors were putting their money.

Even on Friday, many stocks had strong incoming money flows. Here are stocks with particularly high money flows, according to The Wall Street Journal:

Source: The Wall Street Journal.

Pummeled oil and natural-resources stocks dominate the list. But investors picked up bargains in industries that span the entire economy.

The flip side of that figure, however, is that money flows don't tell you whether a particular trade is a long-term investment or a short-term play. On Monday, for instance, during the Dow's record point rise, many oil and commodities stocks had negative money flows -- a suggestion that investor interest was short-lived.

Ignore the short run
It's always nice to buy at what proves to be the ultimate bottom, as Friday's buyers may have succeeded in doing. Yet even if you missed out on Friday's big bargains, don't obsess too much about the short term. Even if you don't invest a single penny more in the market now, you're doing much better than a lot of Main Street investors who panicked themselves out of the market after its big drop.

Regardless of the current volatility, fundamentals will eventually reassert their dominance over stock prices. If you buy shares of good companies that have gotten beaten down, then you should do well over the long run. On the other hand, if you grab any bargain you can find regardless of its future prospects, then you're gambling with your life savings -- and you could easily see further losses.

As you gain experience as an investor, you'll learn more about how to take advantage of weaker players in the market. It doesn't matter whether you're benefiting from scared individual investors or liquidity-squeezed hedge-fund managers. Any time herds of people are rushing for exits, you should be bucking the trend and trying to figure out the best way to get in.

For more on the panic of 2008:

• Did Buffett get bludgeoned? Not a chance.
• You can beat the irrational market.
• Even the government's buying stocks.