How To Profit From Market Manias

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The market has lost its mind.

Daily market swings have gotten a little out of hand lately, much like a see-saw being used by sugar-overloaded children, each trying to send each other flying off.

Yesterday’s 918.35 intraday point swing in the Dow was the ninth largest in history. The rally killer was news that the U.S. would be placing additional tariffs on Chinese imports, which is not exactly shocking information given the current state of our trade war with China.

Today, the Dow rallied for a triple-digit gain, closing 431.72 points higher than yesterday’s close.

Anyone who claims that humans are rational creatures has never closely followed the stock market!

Robo-advisors and other algorithms make life more difficult for us mere mortals with our silly emotions. When the market swings, they are programmed to react. They don’t think for themselves or get scared they might lose their investments — they just do what they’re told.

The average human investor, instead of seeing stocks on sale, gets squeamish and sells into the decline, blind to opportunity.

You, however, are an intrepid individual investor! You should be waiting to pounce with cash on hand, ready to take advantage of overreactions and prevailing herd mentality that you know is foolish and unwarranted. When former bulls start stampeding towards the exit, you will be there, calmly aware of the strong fundamentals that will likely cause a rebound in sentiment.

Stay vigilant, my friends. When selloffs get out of control, like yesterday, you must be poised and prepared to buy your darlings on momentary weakness. When a stock with $13 billion in free cash flow drops 10% after slightly missing earnings expectations from analysts, does that make any sense? If the
NASDAQ
falls 2% and drags
Microsoft
down with it, why not snatch up some shares at a discount?

There’s no getting around it — if you want to grow your wealth faster, you’ll have to take on some risk and be able to stomach some volatility. That doesn’t mean you should look for the highest risk, highest reward investments.

The key is taking on measured, calculated risks. The best investors refuse to take high-risk investments; instead, they concentrate on managing acceptable risk. How comfortable are you with taking short-term losses while you accumulate within your portfolio?

Many investors try to diversify by buying ETFs in a variety of sectors, or index funds that mimic the market. ETFs that concentrate on sectors expose you to sector risk, however, as stocks in that sector all move together. Index funds expose you to overall market risk, as you’re basically just buying the entire market.

If you’re investing in an ETF or index fund, you can’t cherry pick the best stocks for your portfolio and you’re stuck with underperformers that drag your returns down. As an individual investor, you have the freedom to construct your portfolio however you choose.

Of course, no one knows where the bottom is when people are looking for a way out. You don’t want to get caught trying to catch a falling knife. You can avoid this by only buying in small increments, testing the waters with your hypothesis.

If you’re correct and the stock rebounds, you can continue to buy on the way up. If you’re wrong and the stock keeps sinking, you can buy more for a lower price or, if you’re dead wrong and the falling knife leaves you with bloody hands, at least you’ll still have your arms.

I’m a permabull, an optimist who believes in the long-term growth of American businesses. I don’t like to bet against their successes. Though the bears will have their say at some point, I know that, over the long run, we bulls will prevail.

If you own stock in a company and you believe in its long-term value, why would you sell out when there’s a selloff? When the robots and the institutions and the weak-stomached want to sell, they need to find a buyer. If you bought a stock like
Netflix
at $400, why wouldn’t you buy it again at yesterday’s close of $284.84? What has changed for its future prospects that convinced you to sell out?

I believe we are still in the midst of a secular bull market and don’t think we’ve reached the market top. The volatility and correction we’ve experienced this October seem like healthy corrections as part of a strong economic cycle. All the fundamentals are in place for this to continue for some time.

Like a well-built house in the Northeast, I’ve insulated my portfolio from some of this volatility. While I have several growth stocks for (potentially) higher returns, a large percentage of the portfolio is invested in defensive, income-generating companies. These stocks have a reliable history of steady free cash flow and consistently raise their dividend year after year.

When a bear market does finally rear its ugly head, I’m fairly confident that I can weather it out, generating cash on a monthly or quarterly basis so that I can bargain hunt while prices are low and hold on until the bulls come charging back.

It pays to have your head on straight while others are losing theirs. See-saws can be fun, especially if you’ve got a strong grip on the handles!

 Disclosures: None

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