by Keith Fitz-Gerald 10/03/08
During a two-year stretch every 20 years or so, the Standard & Poor's 500 Index (SPX) can be expected to lose 35% or more of its value.
In 1974, according to research by Ibbotson Associates, that truism manifested itself as a 37.25% downdraft. It was even worse in 2002, when investors received a 41.65% haircut.
As bad as those downturns were, they were a mere shadow of the poleaxing that investors received in 1932 -- during the depths of the Great Depression -- when the U.S. market plunged 80%.
But uncertainty breeds opportunity - and in the financial markets, uncertainty can bring with it some of the biggest profit opportunities you'll find. Investors who are able to strike a balance -- managing their risks as they capitalize on the opportunities the uncertainty creates -- will position themselves for some potentially handsome long-term profits.
A Fully Stocked Investors' Survival Kit
To help you strike this balance, I'm breaking out my market-survival kit -- what I like to refer to as my "Three Keys to Success in Volatile Markets."
- Control what you can; manage what you cannot.
- Always remember that it's harder to get out of a trade than it is to get into one.
- Ban wishful thinking from your investment analysis.
Let's take a look at these one at a time.
Control What You Can; Manage What You Cannot
First, there's a reason I say to "control what you can, manage what you cannot." Financial markets can - and often do - fall much more frequently than we'd care to admit, and often for reasons well beyond our control (even though we'd like to believe otherwise).
What this means, in very plain English, is that big declines are part of the investing landscape and that we need to be prepared for them - not just some of the time, but all of the time.
When investors read this rule, their initial thought usually is that it's meant as a warning - telling them to avoid big losses. The reality is that this rule was put in place to ensure big gains.
Time and again, history demonstrates two key facts:
- The biggest stock-market returns go to investors who put capital into play when the markets are at their worst - think of the profits reaped by investors who took the plunge in 1932, 1942, 1982 and 2003.
- And that the worst returns go to those who invest when markets are highest - think 1928, 1969, 1999, and 2007.
The trouble is that -- as sound and clear as this bit of market wisdom actually is -- it runs completely counter to what investors' emotions tell them to do (or not to do) in their quest for profits.
That brings us to volatile-market success key No. 2.
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