There is an old investment saying that “in a bull market, everyone thinks he’s a genius.” It’s true. When entire indexes skyrocket for weeks or months at a time, it often looks like investors are reaping the rewards of a methodical approach. Some investors openly credit their pet theories or formulas for their huge returns. In reality, that is rarely the case. Most investors who prosper during bull markets are simply riding unsustainable, mania-driven waves.
Indeed, it is investing during bear (or down) markets that actually requires real insight.
Be Skeptical of Mainstream Media
The mainstream media is an investor’s best friend when the market soars. Generally, you just buy whatever the talking heads say you should. The media played no small role, for instance, in persuading the public that “the Internet” could single-handily make fledgling, profitless companies worthy of IPOs. The housing bubble, too, was propelled in part by the media’s endless coverage of rising home prices and stories about real estate speculators getting rich. If the market is booming, just do what the media seems to be focusing on and pray you sell before it tanks.
When the market does tank, though, the media is an investor’s worst enemy. In their endless quest for ratings, the media exaggerates how bad even the very worst of times really are. The effect of their constant nay-saying is to convince large numbers of people that “the economy”, in its entirety, is doomed. Too many investors reason, from this feeling, that down markets simply “aren’t the time” to invest. Simply put: ignore 90% of what the mainstream media has to say about the market. They are rarely a valid source of analysis.
Exploit Irrational Despair
The same impulsive manias that drive booms are frequently in effect when the market goes down. In late 2008, Harvard MBA John T. Reed observed that “10% of all publicly-traded companies are valued by the stock market at less than the amount of cash in their bank accounts.” Reed’s explanation of this mystifying phenomenon? Irrational despair. Just as irrational exuberance can propel stock prices to the stratosphere, irrational despair can cause investors to abandon valuable securities at far less than market value.
In down markets, shrewd investors have opportunities to capitalize on the irrational despair of others. If you see securities being sold out of generic fears about “the economy” rather than any specific metrics pertaining to the security itself, stay alert! It could be that these securities are being undervalued – all due to sheer paranoia.
More from GFC, Below
Acknowledge Sunk Costs
Down markets, by definition, are characterized by massive losses. Yet how these losses are perceived and dealt with can make all the difference between investing smartly or foolishly. Some (perhaps many) investors treat their losses as mere “paper losses” that do not become “real” until they sell the fallen security. Hang on long enough, they believe, and the great stock market pendulum in the sky will “bring it back” to its old price. They assume the old price was the “real” price and the recent drop is just an aberration.
In fact, there is no dividing line separating “paper losses” from “real losses.” A loss is a loss. If you own 100 shares of stock valued at $50 a share and it falls to $30, you have lost $2,000 as genuinely as if someone took it out of your hands. Holding onto it exposes you to the risk of it falling to $20 per share or $10 or $0. The lesson to absorb here is that you must recognize a loss for what it is: a sunk cost. Even if the stock rises once more to $50 a share, it is nothing more than an unrelated price increase. You wouldn’t take a lavish European getaway based on a hoped-for raise at work, and you shouldn’t hold bad investments based on a hoped-for share price increase.
Study The Cause(s) of the Downward Economy
Finally, there is something to be said for having a firm intellectual grasp on why the market is down in the first place. After all, not every crash has the same cause. Take the tech bubble and the housing bust as just one example. While each appears on the surface to have followed a remarkably similar path, the details are vastly different. An astute observer can gain a wealth of insight (including hunches on how to exploit irrational despair) from understanding the mechanics of why the market is the way it is.
Sadly, the mainstream media is, again, rarely of help. While some shows and reports are valuable, you are perhaps best served to read relevant blog posts, books and articles on the situation. Timelines are especially helpful, as they tend to pinpoint the key moments and turning points of the crisis. Hockey legend Wayne Gretzky claims the key to his success was thinking in terms of where the puck was going, rather than where it already was. In investing, the only way to predict what happens next is to know what happened first.
In sum, teaching yourself to invest in a downward economy is about un-learning bad lessons you might have absorbed and keeping your eyes peeled for opportunities. The media is generally to be ignored. If anything, their constant melodrama and nay-saying will only erode your focus and resolve. Panicked investors tend to irrationally dump valuable securities during down markets, creating opportunities for savvier investors. Losses are to be acknowledged as sunk costs, and you ought to study the deeper facts about what is going on.
About the Author: Dan Wesley is a writer for Creditloan.com. Established in 1998, Creditloan.com has been providing insight, advice and news on a range of financial topics, such as personal loans, debt consolidation and cash advances. In addition to the thousands of articles, you will also find reputable service providers and tools that will help you with all of your budgeting needs.