Market Corrections / Strategies / 7 Tips

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Market corrections occour sometimes serveral times a year but normal we see them only after some years of growth. Everybody should know that there is no way around it. Markets generally move in cycles! But reaction with advantages for the investor is possible.

The stock market has spent historically more time on bullish advances than on bearish retreats. This is the reason why stocks have been considered a good investment over the years. The characteristic of the market also is that the market tends to retrench more than the average investor would like to think about. The definition of a bear market is a 20 percent or greater decline in stock prices as measured by the Dow Jones Industrial Average, the DAX, the stoxx50 or other relevant index from all over the world. A full-fledged bear market can persist for many months or, in very rare cases for some years. Normally indexes increases. 

It also happens that some corrections, on the other hand, are sharp, but brief, lasting only a day or two or for a few weeks. An example: The Dow’s 500-point drop in October 1987. It occurs that sometimes a short, dramatic decline serves as a prelude to a lengthier downturn. The 1929 crash resulted in a subsequent three-year bear market, which saw the Dow lose almost 90 percent of its value, illustrates this latter possibility for everyone who is investigated.

The securities-industry officials and the government are constantly learning from their experiences with previous declines. Regulations which have been established in the wake of the 1929-1932 bear market have helped prevent another decline of similar magnitude. As an example, margin requirements were raised from 10 percent to 50 percent to prevent investors from becoming excessively leveraged respectively indebted the way many were in the months leading up to the crash in the year 1929.

After the 1987 correction more refinements were introduced, including our current system of circuit-breakers. In theory, these circuit-breakers would stretch out a decline over several days rather than allow it to gain momentum immediately. The additional time would help curb panic selling is the assumption.

It cannot prevent market corrections although the securities industry is committed to doing everything in its power to protect investors. It is essential for investors to take their own responsibility for their investment activity and to arm themselves with as much knowledge as they can get about the risks and potential rewards of investing money.

The Cowles Commission, formed to guide investors through the aftermath of the 1929 crash In the 1930s and came up with five essential rules for successful investing, which are still applicable today in the new century.

7 essential rules for successful investing

1. Your should invest for the long term.

While the stock market can be very risky over the short term the risk decreases as your investment time horizon lengthens. A good rule of thumb is that bond and stock investments should be funded with money you would not need for at least five years.

2. You must invest systematically.

It is one way to avoid the timing dilemma if you use a simple strategy called money-cost averaging. Money cost averaging is the practice of investing a fixed amount of money in a particular investment at regular intervals. The amount invested the best should be constant. Then the investor buys more shares when the price is low and fewer shares when the price is very high. The result will be that the average cost per share tends to be lower than the average market value of the whole investment over the same period of investment.

3. Market timing.

Some of the investors hope to improve their returns by selling a portion of their holdings just before a correction. Such a “market timing” is something that even for professional investors it is a difficult behavior with any consistency and is not recommended for the average investor. But who accepts to be a average investor?  Aside from the very real difficulty of identifying the beginning of a new market phase and the end of a market phase, the basic emotions of fear and greed work strongly against those who attempt market timing, constantly tempting them to overstay their positions in a bull market and to remain on the sidelines for mostly to too long in a bear market. Market timing is more than difficult.

4. You must diversify investments.

When thinking about investing the money, people probably envision themselves comparing the merits of various investments. But there is a important things to be done before. Before investors get to that step, there is a more basic decision to make, the asset allocation. Asset allocation is the percentage of investment funds an investor allocates among asset classes such as cash equivalents, stocks, tangibles/real estate and fixes income.

5. Money-cost averaging.

It must be ever in your thoughts: Dollar-cost averaging cannot eliminate the risks of investing and can not guarantee a profit or protect against a loss in declining markets. The success of your investment program depends on making regular purchases through declining and advancing market periods and also on selling when your investment is worth more than the average price you paid in the past. Since such plans involves continuous investment in securities, each investor should consider the financial ability to continue purchases also through the periods when there exist low price levels. But money-cost averaging does offer a really disciplined method of investing money in the securities markets and lowers the price you have to get to break even. It is your choice to do so.

The final decision is an important one. A study of large pension funds has been shown that a pension manager’s allocations among different asset classes had a far greater long-term effect on the returns than the individual securities one has selected. Nevertheless, asset allocation or investment timing really cannot eliminate the risk of uncertain returns or fluctuating prices.

6. Researches have shown: Buy quality.

Investors become enamored with initial public offerings (IPOs) periodically. IPOs can be an appropriate investment for those who know how to invest in them and understand the risks. By definition IPOs involve companies whose stocks are untested in public trading. But the average investor should approach this arena with really extreme caution and commit no more than a small percentage of investment capital to initial public offerings.

At the other end of the spectrum are so many companies with histories of earnings growth and consistent sales. You ever must have in mind that never anything is guaranteed in the investment markets. There is a lower probability that such companies will drop off the investment map during a drastically correction. Rather such a correction presents investors with the opportunity to acquire more shares of historically seasoned, financially sound companies at reasonable prices they will never get again in future.

7. For everyone who is unsure of investment, get professional advice. 

Each of the investors brings a different outlook and level of sophistication to the different markets. Most investors can benefit from some degree of professional input. Whether that means professional research on advice on asset allocation, individual securities or entrusting money to professional portfolio managers, investment professionals are great resources for helping investors achieve their financial goals for the most secure investments that are possible. Particularly during correction period it helps a lot to have a coherent investment strategy worked out in advance of the corrections and to be able to keep that strategy clearly in mind as events unfold. Also in such times a qualified investment professional can help plan a recent sound investment strategy and a strategy for the future.

25.02.2009