Expert Q&A: How to Stay Calm When Volatility Strikes
The stock market just closed out a terrible September, marked by an uptick in volatility and renewed fears over the economy and coronavirus pandemic. The S&P 500 fell 3.9%, its worst month since March.
Legendary investor Peter Lynch once said: “You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in the markets.”
As the contentious presidential election looms in November, we face more turbulence. But you don’t have to sit on the sidelines. I asked my colleague, Jimmy Butts, for advice on how to stay calm when volatility strikes.
Jimmy Butts [pictured] is the chief investment strategist of the premium trading services Maximum Profit and Top Stock Advisor.
In our discussion, Jimmy imparted timeless rules for keeping your investment strategy on an even keel. My questions are in bold.
As anxieties rise on Wall Street about the presidential election and the resurgent coronavirus pandemic, the stock market appears poised for a big tumble. How can investors prepare their portfolios?
There are concepts that will help you become a better investor. Not only that, they could also help you manage your way through the next market meltdown.
The concepts I’m going to talk about are easy to grasp. But what makes them difficult to execute is our emotions.
You may have heard people say, “I hate losing more than I like winning.” While this sentiment often pertains to sports or some other event of a competitive nature, it’s precisely the sort of thinking that often causes investors to lose their shirts.
Of course, nobody likes to lose, especially when it comes to money. But that fear of loss overcomes our rational self and greatly decreases the probability of success.
You see it happen in the sports world all the time. A team is up big and it begins playing “not to lose.” Instead of continuing to do what got them into the winning position in the first place, they seize up. The fear of losing the lead, and the game, overcomes them. Sometimes they squeak by with a narrow win, other times they give up the lead entirely.
Along those lines, you adhere to “prospect theory.” Explain what that means.
In investing, there’s a human tendency to behave irrationally when it comes to taking profits and losses. According to Economics Nobel Prize winner Daniel Kahneman, this is known as prospect theory.
One of the hardest things to do is keep your emotions from clouding your judgment. Once you allow emotions to get the better of you, you lose your confidence, self-doubt creeps in and you begin second-guessing yourself with every investment or move you make.
Emotions make you question everything you’re doing in the markets… especially during turbulent market environments as we’re seeing now.
A lot of factors are disrupting the status quo, including a norm-shattering election and a lethal global pandemic. Investors need to stay calm and stick to the fundamentals.
How should investors behave when the next bout of volatility hits?
Nobody likes to be wrong. And taking a loss is proving exactly that… that you were wrong.
It’s been proven that investors tend to sell their winners too early. It satisfies their desire to be right. They also hold on to their losers too long. After all, as long as you don’t sell, you still haven’t admitted that you were wrong.
The simple fact is that we as investors will be wrong. It happens to the best of us. And chances are good that we’ll be wrong quite often. But as prominent investing magnate George Soros once said, “It’s not about being right or wrong, rather, it’s about how much money you make when you’re right and how much you don’t lose when you’re wrong.”
One of the simplest and most effective ways to protect your capital is through risk management. Establish strict sell or loss parameters and follow them.
One popular risk management method is the 2% rule, which means you never put more than 2% of your account equity at risk in any single trade. For example, if you are trading a $50,000 account and you choose to use the 2% rule, that means you are willing to risk $1,000 on any given trade. The great thing about this rule is that if you stick to it, you would have to make dozens of consecutive 2% losing trades in order to literally go broke. And even for a novice investor, this is highly unlikely to happen.
Keep in mind that the 2% number is arbitrary; you can adjust it to fit your level of risk tolerance. But it provides investors with a foundation on which to make trading decisions.
Determining the proper position size before placing a trade will not only dramatically impact your trading results, but it will help put your mind at ease.
If you can master the art of understanding losses and position sizing, you will be leaps and bounds ahead of other investors.
To be sure, these are guidelines that can be, and should be, used by investors of all shapes and sizes. Plus, having a plan in place will help you sleep better at night during market drawdowns, knowing that you aren’t taking extraordinary risks with your capital.
Editor’s Note: Jimmy Butts just outlined for us basic investing principles. Our mutual colleague Dr. Stephen Leeb understands these ideas better than anyone, which is why he’s been guiding his subscribers to win after win in any market environment.
Dr. Leeb, chief investment strategist of The Complete Investor, has coined a term for the stock market’s recent behavior. He calls it “Reset 2020,” and he believes it signals a paradigm shift in how equities will be valued in the years to come. To learn more about this shift and how to profit from it, click here for our special report.