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How To Live Through A Crash And Benefit From A Recession

Apr 27, 2008
1. Buy And Hold - And Not Get Carried Away By Emotions

The difference between the drop in 1987 and many other market drop was the rapid recovery. It didn't even take a year. By comparison, when the market dropped 86% of its value from 1929 through 1932, it took 12 years to get back to break even. And when the bear market that began in 2000 cut the market in half, it took until 2003 before the recovery started.

If someone could foresee when those really ugly times would start and stop with the kind of accuracy to beat the buy-and-hold investing strategy, that would be terrific. Unfortunately, there is no evidence that anyone can do that with regularity.

2. Ignoring The Crowds And Going In The Opposite Direction

There's a distinct difference between paying attention to the market and panicking. For long-term investors, buying assets at a discount when the markets are down and everyone is in panic mode makes sense, so when there are sectors and/or assets that seem cheap, that's when it's time to stock up.

Conversely, making a cut away from assets and/or sectors when everyone is in a buying frenzy overheating the market, makes some sense too. It's called buy and hold, not "buy and forget about it," and the purchase decisions should include some mix of your outlook on the market and your personal portfolio needs.

3. If You Can't See Yourself Owning Something For 10 Years, You Probably Shouldn't Buy It At All!

Now don't get me wrong. I'm not saying that you shouldn't buy assets like options that you keep for a while and then sell again, hopefully at a profit. That's what I do too. But 80 to 90% of your hard earned money should be invested wisely and on a long-term basis! And that's where the following come into play.

Unless you are a clairvoyant with perfect timing abilities, you will lose more by selling when the markets go down and getting in again when the markets go up, instead of keeping your assets.

The reason again is psychological. Because you can't look into the future, you will not know for certain when the markets go for the big dip. So chances that you will sell in time are slim. And when the markets eventually go up again, most people are afraid of getting in out of the uncertainty whether the decline is really over. So by the time they pluck up some courage to get in again, they will have missed a whole chunk of the uptrend already.

On average, bear markets occur once every 4 to 5 years. But if you look at the periods in between, you'll see that stocks make money nine times out of every 10 during those in-between periods. The odds of making money over 10-year periods are even better.

So if you can't see yourself owning something long enough for the odds to be in your favor, you shouldn't buy at all!

4. Don't Look Back. All That Matters Is What Happens Next

Past performance is no indication nor guarantee for future success and profits and a stock chart is a picture of price movement over time. So what you see today has happened already. So the future may not necessary resemble the past.

Now I'm not saying that one shouldn't look at charts in order to analyse what the probable outcome in future may be. On the contrary. But too many people try to chase after past performance. I've seen just too many people believe that just because a $20 stock was trading at $100 before, it's going to see that mark again. And so they start trading without any fundamental background and knowledge about the company they want to trade.

After a strong downturn, take a look at each company that you consider trading on it's own merits. Very often there's a reason why a company that traded at $100 before is now down to $20, for instance.

Always trade and invest so that you survive and can trade and invest another day!

5. There is no one right way

Learn and adopt a system that suits your trading style and personality using a clear plan for your trades because without your chances of profitable trading are profoundly limited!

But always bear in mind that there isn't the one and only fool-proof trading system that eliminates all risk! There's risk of loss in all trading! Every investment strategy has its pitfalls. Know them well enough to stick out the times when they come into play, or you will bail out on your strategy at the worst possible moments. No strategy works if you play it that way.

Trading is no rocket science! But neither is there a perfect formula with which you can work out whether you're going to be right or wrong when you enter a trade. It's all about probability and how the majority of the traders behave and react to news and events.

But finding an investment strategy that you can live with and sticking to it is crucial! It lets you sleep at night and allows you to stay cool when the market's steer towards a bad day again!

How You Can Benefit From A Recession.

First of all, by finding and sticking to a investment strategy that suits your personality as I said before. But a good way to benefit from a recession is cost averaging.

Now a lot of times cost averaging is also referred to Dollar-Cost Averaging. If you read financial books or search the web on cost averaging, you'll come across this way of putting it in most cases. This is probably again due to the fact that 60% of all financial activities take place in or via the United States, which is the world largest financial market.

But it has nothing to do with the Dollar only! Whether you take Dollar, Euro, Pound or Yen, it doesn't matter! You can use this method with any currency.

What is Dollar-Cost Averaging?

Dollar-Cost Averaging is a technique designed to reduce risk through the systematic purchase of securities by investing a fixed amount of money at set intervals. The investor buys more shares when the price is low and fewer shares when the price is high, thus reducing the overall cost.

Mathematically it works like this:

Let say, for example, that you bought Microsoft shares at a price of $80 and they dropped down to $40. That's a 50% loss and your stocks would have to go up by 100% for you to break even again. I know this sounds unfair but that's the way math works sometimes. You lose half but you have to gain double to get back from where you started.

But not so when you average your costs. And this is how you do it:

When Microsoft drops down to $40, you repurchase Microsoft at $40 by the same amount of shares.

Why?

Because now you don't have to wait until Microsoft goes up to $80 again to break even. The break even point now is at $60 and anything above that is a gain.

If you like I can also put it in numbers:

$80 (your first purchase) + $40 (your second purchase) : 2 (because now you bought the same amount of shares for the second time) = $60. Meaning, that you average purchasing costs are now down to $60 per share and not $80 anymore! So once Microsoft goes up again you'll be in the green much faster.

The math gets a bit more complicated if you would only repurchase 10, 15 or maybe 40 percent of the shares you originally bought instead of the same amount. But, simply put, that's how Dollar-Cost Averaging works!

Many successful investors already practice this without realizing it. The Dollar-Cost Averaging strategy is just as applicable to mutual funds as it is to common stock.

If you invest in a mutual fund on a monthly basis, you automatically practice dollar-cost averaging because you still keep investing consistently even though the market is down.

Implementing this can substantially reduce your long-term market risk and result in a higher net worth over a period of ten years or more due to the fact, that you break even and get back into the green much sooner.

Creating Your Own Plan

To sum it up, you can do 1 of 2 things, or even both.

You follow a Dollar-Cost Averaging plan by purchasing and repurchasing shares.

You can purchase a mutual fund and automatically follow a Dollar-Cost Averaging plan on a consistent basis.

In order to begin with this, you must do three things:

Be clear about how much money you can invest each month. Make certain that you are financially capable of keeping the amount consistent; otherwise the plan will not be as effective.

Select an investment (mutual funds are particularly suitable) that you want to hold for the long-term, preferably ten years or longer.

At regular intervals (weekly, monthly or quarterly works best), invest that money into the security you've chosen. The easiest is to set up an automatic withdrawal plan so that you don't have to worry about making regular transfers or even forget making them. Include your regular investments into your monthly budget so that you don't get into the habit of skipping a payment here and there because you need the money for other things.

Yours in Successful Trading

Ricky Schmidt
About the Author
Ricky Schmidt's websites http://www.stockbreakthroughs.com and http://www.stockbreakthroughs.com/blog was created out of frustration in trying to decode books, magazines and newsletters on the subject, which are supposed to be for beginners but are not because they're too difficult to understand. Too many "Big Words" and too much intelligent sounding grammar is used which is not very useful.
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