When we talk about investing is the stock market, there is always a subject that is almost considered a taboo: Stock Market Crash! Yes, everybody gets excited when the stock markets are going up, but at the slightest sign of a potential stock market crash, most of the amateur and DIY investors start to panic. Don’t get me wrong, I was once a new investor who also thought that a stock market crash was the worst thing in the world and I did some very bad choices out of fear, but the worst decisions I made where: Not Investing in the Stock Market our of fear of a crash, and, Selling everything I owned because it was going down and I could buy those stocks later for a better price (Sell High Buy Low…) but as you probably know, I ended up selling low and buying high… So much for smart investing eh?
I don’t want you to make the same mistakes I did, so I’m going to show 5 things that you can do when other investors are panicking because a stock market crash is just around the corner:
1- Don’t panic!
Get away from your computer, put your phone away and stop checking the stock market every minute. Human behavior hasn’t change in 1000’s of year, we tend to be overly optimistic when things are going good, and overly pessimistic when things are going bad. I made my worsts decisions in the stock market when I was very pessimistic about the possible outcome and sold my stocks at the absolute bottom because I thought that “It’s going to get a lot worse, I might as well protect my account” and “I’m going to be super smart and sell my stocks right now because I can buy them back for a better price”.
Well, those decisions never went according to the plan, I sold my stocks at loss, and when the stocks bounced and went up, I bought them higher, way higher than the price I sold them for… So if I instead of panicking, decided to do nothing, just sit down, relax and enjoy the ride, I would have recoup my money and make some more.
How did I overcome this? I no longer check my account when the stock market is open, not even the news or the price of my stocks while the market is open. I only do it when the market is closed. Why? because if I panic and want to sell my shares, I can’t do it, because the market is closed!
“People who succeed in the stock market also accept periodic losses, setbacks, and unexpected occurrences. Calamitous drops do not scare them out of the game.” – Peter Lynch
2- Remind yourself that you are a long term investor
Stock market crashes are bound to happen, is a fact and we can’t get away from it, but there is one thing that has been true since the early days of the stock market, the only thing that is certain is that no matter what, the stock market will always go up in the long term. This is the reason why long-term investors are not worried with stock market crashes and also why short-term investors are heavily affected by this crashes.
If you buy a stock because you are comfortable holding it for 5 years or more, then a market correction or crash is just a bump in the road and in a couple years you will do better, but, if your plan was to hold the stock for 1 week or 5 months and suddenly drops, then you are in big trouble, and is going to be even worse if those short-term investors are using margin account (borrowing money) to do it.
“The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as long as the fundamental story of the company hasn’t changed.” – Peter Lynch
3- Hold or buy more shares of your favorite stocks
The stock market is a funny place. If you have the money to buy the latest and greatest smartphone, you will have no problem spending the money because you really like the phone, but if for some reason there is a flash sale where you can buy the same phone for 20% or 30% discount, you will rush to store and buy it. Well, in the stock market happens the complete opposite, people are happy to buy stocks when they are high and when those stocks get “discounted” they rush to sell them!…. This is why most DIY investors lose money!
What you can do instead is the following, check if the fundamentals of the company are still the same, if nothing has changed, if the company is the same, then a stock market decline will be the perfect opportunity to buy your favorite stocks for a discounted price. Buy more shares if can, which will lower the average price per share and will net you better returns when they go up again. If you can’t buy more, the by all means don’t sell them, just keep holding your stocks.
“Be fearful when others are greedy, and be greedy when others are fearful” – Warren Buffett
4 – Know what you own
You have to know what you own, this is key to protect yourself from pain in the stock market, if you know you own a strong company, that is constantly making more money, that is not racking debt and the service/technology is great, then you shouldn’t be worried about the stock on a market crash. Obvious examples of this kinds of stock is Walmart and Costco, because no matter what, people still need to buy groceries and eat, and this companies have strong performances and have a clear plan to stay in the market. In contrast to this idea, is holding a penny stock that has a wonderful but unproven idea with no revenue and a ton of debt. That penny stock is indeed scary to hold and most likely will cause you pain in the long-term.
The big problem here is that we as consumers, we do a lot of research before buying a product, we spend hours on amazon reading reviews, we go to YouTube and watch reviews and comparisons to similar products, we can spend days in this process, but when it comes to investing, the average DIY investor buy a stock because they heard a recommendation on the radio, or a friend told them to buy the stock, so when the stock goes down, they have no idea why did it happen and blame others for the current result. What an irony right?
5 – Diversify your portfolio
You need to have a diversified portfolio, you can’t have too much weight on just one stock or sector, If half your portfolio is just sitting in in just 1 or 2 stocks, then your account will take a massive hit whenever there is a drop in the market. The stock market is not the place to make bets, if you are betting on a stock by allocating big portions of your money into it, you need to rethink it and reduce your exposure to that stock. A portfolio that is well diversified will have a much slower decrease when the stock market hits a banana peel.
Keep in mind that you shouldn’t diversify just for the sake of diversification, you still need to know what you own! I wouldn’t recommend holding more than 18 stocks since that would be one too many stocks to keep track of and by owning way too many stocks you will be close to replicating an index performance, which in that case, you will be better buying that index ETF!
“If you have trouble imagining a 20% loss in the stock market, you shouldn’t be in stocks.” – John Bogle
Next time the stock market hits a banana peel and starts behaving irrationally, you should sit back and relax, understand that a correction is a very beneficial event, that doesn’t last long and gives you an excellent opportunity to buy more of your favorite stocks with a nice discount.
There’s one thing that I would like remind you, never invest money that you need in the next 12 months or that you can’t afford to lose, if you are forced to sell your stocks because you need to have a down payment for a house, you could probably sell them at loss because the stock market had a mini crash, which would defeat the point of your investments, we are here to make money, not to lose it!
Keep calm and enjoy the ride!
If you are interested in stock market psychology and mindset, I recommend you this post: