7 lessons to learn from a market downturn

You can never really understand investing until you weather a market downturn. The valuable lessons learned can help you through the bad times and can be applied to your portfolio when the economy recovers. Listed below are some common investor experiences during tough economic times and the lessons each investor can come away with after surviving the events.
Lesson #1: Evaluate your egg baskets
You're pulling your hair out because everything you invest in goes down. The lesson: Always keep a diversified portfolio, regardless of current market conditions.
If everything you own is moving in the same direction, at the same rate, your portfolio is probably not well diversified, and you could stand to reconsider your asset-allocation choices. The specific assets in your portfolio will depend on your objectives and risk-tolerance level, but you should always include multiple types of investments.
Taking a more conservative stance to preserve capital should mean changing the percentages of holdings from aggressive, risky stocks to more conservative holdings, not moving everything to a single investment type.
For example, increasing bonds and decreasing small-cap growth holdings maintains diversification, whereas liquidating everything to money market securities does not. Under normal market conditions, a diversified portfolio reduces big swings in performance over time.
Lesson #2: No such thing as a sure thing
That stock you thought was a sure thing just tanked. The lesson: Sometimes the unpredictable happens. It happens to the best analysts, the best fund managers, the best advisors, and, it can happen to you.
The perfect chart interpretation, fundamental analysis, or tarot card reading won't predict every possible incident that can impact your investment.
Use due diligence to mitigate risk as much as possible.
Review quarterly and annual reports for clues on risks to the company's business as well as their responses to the risks.
You can also glean industry weaknesses from current events and industry associations.
More often, an investment is impacted by a combination of events. Don't kick yourself over unpredictable or extraordinary events like supply-chain failures, mergers, lawsuits, product failures, etc.
Lesson #3: Proper risk management
You thought an investment was risk-free, but it wasn't. The lesson: Every investment has some type of risk.
You can attempt to measure the risk and try to offset it, but you must acknowledge that risk is inherent in each trade. Evaluate your willingness to take each risk.
Lesson #4: Liquidity matters
You always stay fully invested, so you miss out on opportunities requiring accessible cash. The lesson: Having cash in a certificate of deposit or money market account enables you to take advantage of high-quality investments at fire sale prices. It also decreases overall portfolio risk.
Plan ahead to replenish cash accounts. For example, use the proceeds from a called bond to invest in the money market instead of purchasing a new bond.Sometimes cash can be obtained by reorganizing debt or trimming discretionary spending. Set a specific percentage of your overall portfolio to hold in cash.
Lesson #5: Patience
Your account balance is lower than it was last quarter, so you overhaul your investment strategy before taking advantage of your current investments. The lesson: Sometimes it takes the market an extended period of time to bounce back.
Your overall portfolio balance on a given date is not as important as the direction it is trending and expected returns for the future. The key is preparedness for the impending market upturn based on an estimated lag time behind market indicators. Evaluate your strategy, but remember that sometimes patience is the solution.
Lesson #6: Be your own advisor
The market news gets bleaker every day - now you're paralyzed with fear! The lesson: Market news has to be interpreted relative to your situation.
Sometimes investors overreact, particularly with large or popular stocks, because bad news is replayed continuously via every news outlet. Here are some steps you can follow to help you keep your head in the face of bad news:
Pay attention and understand the news, then analyze the financials yourself.
Determine if the information represents a significant downward financial trend, a major negative shift in a company's business, or just a temporary blip.
Listen for cues the company may be downgrading its own expected returns. Find out if the downgrade is for one quarter, one year or if it is so abstract you can't tell.
Conduct an industry analysis of the company's competitors.
After a thorough evaluation, you can decide if your portfolio needs a change.
Lesson #7: When to sell and when to hold
The market indicators don't seem to have a silver lining. The lesson: Know when to sell existing positions and when to hold on.
Don't be afraid to cut your losses. If the current value of your portfolio is lower than your cost basis and showing signs of dropping further, consider taking some losses now. Remember, those losses can be carried forward to offset capital gains for up to seven years.
Selective selling can produce cash needed to buy investments with better earnings potential. On the other hand, maintain investments with solid financials that are experiencing price corrections based on expected price-earnings ratios. Make decisions on each investment, but don't forget to evaluate your overall asset allocation.
Conclusion
Downward stock market swings are inevitable. The better-prepared you are to deal with them, the better your portfolio will endure them. You may have already learned some of these lessons the hard way, but if not, take the time to learn from others' mistakes before they become yours.

Turn off the TV, calm yourself

Panic is a wild, irresistible fear that spreads through crowds like an epidemic.

Panic. Panic is a wild, irresistible fear that spreads through crowds like an epidemic — and it may be upon us now, with day after day of multi-hundred-point swings in the Dow. The word itself seems almost primeval; it derives from Pan, the goat-headed god of shepherds and flocks in Greek mythology, who was believed to startle people with outbursts of mysterious music in frightening places such as steep mountainsides or dark caves.

Fear is a defence mechanism. It bursts forth in our brains the instant we sense that we, or others near us, are threatened. When fear leaps from one person to another, it turns into panic.
You can catch other people’s emotions as easily as you can catch a cold. In an experiment by neuroscientist Elizabeth Phelps at New York University, people either watched someone else get a mildly painful electric shock or suffered the shock themselves. Their brain responses and their dread before the shock were highly similar in both cases, suggesting that seeing another person’s fear is all it takes to make us afraid. Even encountering the circumstances under which the other person was shocked is enough to trigger your own fear.
Viewed this way, today’s financial markets — in which tens of millions of investors watch each other’s fears unfolding in real time on television as well as online — constitute one giant panic transmission machine.
Research at the University of Toronto shows that in a panic, your eyes widen, your eyelids rise and your eyebrows shoot up, making you hypersensitive to any threat that might come from above.
As you look up at a wall-mounted TV screen, wide-eyed to catch the latest news, you mimic the physical posture of fear. That action may, in itself, make your brain more sensitive to negative titbits of news — and more anxious to act on them.
Meanwhile, the sight of someone tensing up in fright not only triggers the fear centre in your brain but also prepares your muscles to strike the same pose. Thus, like soldiers or policemen on patrol in a danger zone, investors are now abnormally “trigger-happy”, because panic has tensed their muscles for instant defensive action.
Fear also changes the way you think, reducing your ability to solve problems creatively, making you reluctant to consider a wider set of choices and causing you to distrust others. That means you are now unusually prone to acting on a gut feeling, instead of thinking.
With panic pervading the markets, every company’s assets may seem worth less now (even professional accountants, when temporarily frightened, will value a business’s inventory at a 10% discount). And you may be inclined to shun anything unfamiliar, like international or emerging markets’ stocks. Yet the underlying value of most businesses does not hang on what happens in the stock market, and many stocks overseas have become even bigger bargains than US shares.
You cannot brush panic away with willpower alone, but you can quarantine yourself from contagious settings:
Break the circle
Instead of socializing with other investors nursing their losses, hang out with folks who do not obsess over the market. You are less likely to be spooked by dilated pupils, grim faces and quavering voices.
Turn off the tube
The sight and sound of screaming traders with fear in their eyes is enough to fill you with fright, whether you are conscious of it or not. If hitting the mute button won’t suffice to calm you down, turn off the TV.
Think positive
When Warren Buffett feels his blood pressure rising or his nerves on edge, he calms himself down by gazing at snapshots of his family or playing a game of bridge with his friends.
Stick to it
Set yourself the simple, stark goal of investing more money in something you don’t want to own. You may need help fighting your fears, so visit www.stickk.com and make a public commitment to your future action. Buying a stock fund next week is mentally easier than buying it today — especially if you recruit some friends to cheer you on.

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A first person account from Wall Street

Wall Street will never forget Monday, September 29, when the lords of high finance were rudely reminded that it isn't easy to get away with imprudent investments, no matter which Ivy League degree they possess.
In a major setback to not only the Bush administration, but also to global markets, the US House of Representatives on Monday rejected the $700 billion emergency rescue package to bailout bankrupt American financial institutions. The House voted against the package 228 to 205.
The bailout plan was nixed not only because the figure of the financial assistance -- $700 billion -- was almost pulled out of thin air without solid basis, but also because the American taxpayer was supposed to fund it. The anger that bubbled over and poured onto the streets in the form of protests and demonstrations across the United States was one of the main reasons why the plan was vetoed.
The consequences were instant. The benchmark Dow Jones Industrial Average fell by a whopping 777.68 points, the highest ever in American history, to touch 10,365.45. The Nasdaq fell by 199.61 points to settle at 1,983.73.

The meltdown in the US markets has been stunning. And while Americans try to come to terms with the bloodbath, rediff.com spoke to a senior employee of Bank of America about the blackest day in US stock market history.
This is what he had to say:
"I usually go to my office at Times Square at 7 a.m. As usual, I first checked my mails when I reached the office. When the market opened, it was already down by some 300-plus points. We have a huge trading research staff which supports trading activities. In our office we have a couple of floors for trading activity. On the fifth floor, some 400 terminals are located with 4-5 huge screens showing the market movements and also CNBC."
"When the market was down, we understood that long-term and short-term sentiments were affecting it. One of the reasons why the bailout plan was rejected was because of the uncertainty it carried."
"Nobody is sure whether or not the bailout plan will really help. Global equity markets are going to be hit by American developments. Our trading floor was buzzing with activity. Our terminals were showing an unprecedented flow of transactions."
"By 11 a.m. speculation was there that the bailout bill may not help, it may not solve the current financial problems. Some 400 traders of our bank were being aided by internal commentary of our seniors. They were relaying messages after messages to the trading heads. They were trying to understand the situation."
"By noon, as the news came that the bill to rescue the market had been rejected, there was complete silence on the entire floor for a few moments. We were trying to digest what had just hit us. Everybody was awestruck!"
"Our senior managers went into the conference room. When they came out, the market had plunged and lost almost 700 points. The market had overreacted. After lunch, there was feeling that we had overreacted. Maybe, things may not be that bad, after all."
"News from Washington had settled in by then. People just gave up. Whatever strategy they had, it couldn't save the day. The entire trading floor was excited. The move sent shock waves across the financial markets, including the Wall Street, plunging stocks by 778 points (at close of trading)."
"After the rejection of the bailout plan, every face wore an uncertain look on the trading floor. We bankers didn't lose money because we are using clients' money and on a day like this too, we earn money through commission. We made money! My own terminal had 10,000 trades worth over $40 million. We are not worried about what happened today. We are worried what will happen tomorrow."
"People left the trading floor thinking that tomorrow will be another miserable day."
"Some people thought that the bailout was the last chance to stop the United States from sliding into recession. Others think that the bailout plan will help managers. They will correct their own positions and continue to thrive. The bailout plan would have given liquidity to the market. We are not worried about losing one day or gaining one day."
"But America's biggest finance market, market technicals and fundamentals are failing. Were we wrong all these years? We face this question today. We also ask does this bailout rejection mean it is the end of capitalism? Will New York lose its economic edge? Some believe that it is unethical for the US government to bailout failing companies."
"If the US preaches that countries should not intervene in such crises and let market forces take their own course, how can it do the opposite? It is unethical to rescue failing banks. If elections were not round the corner, the bailout plan would have been different."
"Things are looking hopeless because everything is so wrong that it is difficult to keep up hope. We know it will take a long time to rescue the economy. Meanwhile, people will suffer. America has not declared it yet, but it is facing a recession."
"I still think, and would like to think, that America has not failed yet. It is 15 years ahead (of the world) in whatever it does. Only that gap is now reducing. America is innovative and knows how to use others."

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