Showing posts with label market crash. Show all posts
Showing posts with label market crash. Show all posts

Tuesday 25 July 2023

China's historical debt binge

September 2008, pre-Lehman Brothers bankruptcy

In September 2008, China's economy was slowing.   The Shanghai stock market had just crashed.  Property prices were weak.  The Chinese officials said China was entering the middle-income rank of nations, so it was time for it to slow down as previous Asian miracle economies, like Japan, South Korea and Taiwan, had.  They talked about cutting back on investment, downsizing large state companies and letting the market allocate credit, which at this point was not growing faster than the economy.  Between 2003 and 2008, credit had held steady at about 10% of GDP.


October 2008, post Lehman Brothers bankruptcy

Lehman Brothers filed for bankruptcy in the US and global markets went into a tail-spin.  Demand collapsed in the US and Europe, crushing export growth in China, where leaders panicked.

By October 2008, the Chinese government had reversed course, redoubling its commitment to the old investment -led growth model, this time by fueling the engine with debt.   From 2008 through 2018, total debts would increase by $80 trillion worldwide, as countries fought off the effects of the financial crisis, but of that total, $35 trillion, or nearly half, was racked up by China alone.


August 2009

By August 2009, the Chinese government had launched an aggressive spending and lending program that kept China's GDP growth above 8%, while the US and Europe were in recession.  That steadily high GDP growth had convinced many Chinese that their government could produce any growth rate it wanted.

Bank regulators were the only officials who expressed alarm and their main concern was increasingly reckless lending in the private sector.  "Shadow banks" had started to appear, selling credit products with yields that were too high to be true.  


2013

By 2013, shadow banks accounted for half of the trillions of dollars in new yearly credit flows in China.  When Beijing began to limit borrowing by local governments, local authorities set up shell companies to borrow from shadow banks.  Soon these "local government funding vehicles" became the biggest debtors in the shadow banking system.

As the flow of debt accelerated, more lending went to wasteful projects.  By some estimates, 10% of the firms on the mainland stock exchange were "zombie companies." kept alive by government loans.  The state doled out loans to incompetent and failing borrowers.


  • Lending started to flow into real estate

Much of the lending started to flow into real estate, the worst target for investment binges.  Easy loans spurred the sale of about 800 million square feet of real estate in 2010, more than in all other market so the world combined.  In big cities, prices were rising at 20% to 30% a year.

Caught up in the excitement, banks stopped looking at whether borrowers had income and started lending on collateral - often property.  This "collateralized lending" works only as long as borrowers short on income can keep making loan payments by borrowing against the rising price of their property.  By 2013, a third of the new loans in China were gong to pay off old loans.  In October 2013, Bank of China chairman warned that shadow banking resembled a "Ponzi scheme," with more and more loans based on "empty real estate."


  • At the March 2013 party congress, Li Keqiang came in as prime minister.  

He was one of the Chinese leaders who appeared to accept the reality that a maturing economy needed to slow down, which would allow him to restrain the credit boom.  Yet every time the economy showed signs of slowing, the government would reopen the credit spigot to revive it.


  • Dubious creditors grew

The cast of dubious creditors grew increasingly flaky, including coal and steel companies with no experience in finance, guaranteeing billions of dollars in IOUs issued by their clients and partners.  



2014: Chinese urged to buy stocks

By 2014, lending entrepreneurs were shifting their sights from property to new markets - including the stock market.

Even the state-controlled media jumped in the game, urging ordinary Chinese to buy stocks for patriotic reasons.  Their hope was to create a steady bull market and provide debt-laden state companies with a new source of funding.  Instead they got one of the biggest stock bubbles in history.

There are 4 basic signs of a stock bubble:  

  • high levels of borrowing for stock purchases; 
  • prices rising at a pace that can't be justified by the underlying rate of economic growth; 
  • overtrading by retail investors and 
  • exorbitant valuation.  


June 2015, Shanghai market started to crash

By April 2015, when the state-run People's Daily crowed that the good times were "just beginning,"  The Shanghai market had reached the extreme end of all four bubble metrics, which is rare.

The amount that Chinese investors borrowed to buy stock had set a world record, equal to 9% of the total value of tradable stocks.  Stock prices were up 70% in just 6 months, despite slowing growth in the economy.  On some days, more stock was changing hands in China than in all other stock markets combined.  In June 2015, the market started to crash and it continued to crash despite government orders to investors not to sell.

[Comments:

This credit binge had some characteristics unique to China's state-run system, including the borrowing by local government fronts and the Communist propaganda cheering on a capitalist bubble.  But its fundamental dynamics were typical of debt mania.  It began with private players, who assume the government would not let them fail, and devolved into a game of whack-a-mole.  As the government fitfully tried to contain the mania, more and more dubious lenders and borrowers got in the game, blowing bubbles in stocks and real estate.  The quality of credit deteriorated sharply, into collateralized loans and IOUs.  These are all important mania warning signals.

The most important sign was, as ever, private credit growing much faster than the economy.   After holding steady before 2008, the debt burden exploded over the next 5 years, increasing by 74 % points as a share of GDP.  This was the largest credit boom ever recorded int he emerging world (though Ireland and Spain have outdone it in the developed world).]


By mid 2019

By mid-2019 China had, in fact, seen economic growth slow by nearly half, from double digits to 6%, right in line with previous extreme binges.  To date then, no country has escaped this rule:  a five-year increase in the ratio of private credit to GDP that is more than 40% points has always led to a sharp slowdown in economic growth.

[Comments:

China did however, dodge the less consistent threat of a financial crisis, aided by some unexpected strengths.  One was the dazzling boom in its tech sector, without which the economy would have slowed much more dramatically.  Another was the fact that Chinese borrowers were in debt mainly to Chinese lenders and in many cases the state owned bother parties to the loan.  In short, /China was well positioned to forgive or roll over its own debts.  And with strong export income, vast foreign exchange reserves, strong domestic savings and still ample bank deposits, it has managed to avert the financial crisis that often accompanies large, debt driven economic slowdowns.]



Saturday 26 October 2013

Four steps to prepare for a crash

But for the sake of argument, let’s pretend that Time’s cover is wildly bullish and did send a legitimate bear signal to the world. Or maybe tapering will sink stocks.

What would be the proper course of action for investors in a bear market?


1. Understand your time horizon

If you invested 10 years ago for an event this year, you might seriously consider selling your stocks and converting them to cash — but that’s regardless of where you think the market is going. If you need the money in the short term, it doesn’t belong in the market. If you have longer than a few years to invest, don’t worry about a crash as long as you…

2. Make sure your stops are in place

The Oxford Club recommends a 25% trailing stop loss. The stops protect gains as stocks rise and ensure that no single position results in a devastating loss. Since stocks are up so much over the past four years, even if you do get stopped out, you should get out with a profit. This strategy also ensures that you have plenty of cash to get back into the market at lower prices. During the financial crisis, Oxford Club Members were stopped out of positions in 2008 and took profits on many stocks that had risen during the previous bull. That freed up capital to get back in during the lows of 2008 and 2009, resulting in some huge winners, including Discovery Communications (Nasdaq: DISCA), up 255%, and Diageo (NYSE: DEO), up 171%.

3. Review your portfolio

If you haven’t done so in a while, take a look at the stocks in your portfolio. Make sure the companies are still operating at a high level. If you own Perpetual Dividend Raisers — stocks that raise their dividend every year — examine when the company last raised its dividend. If the company is continuing its streak of annual dividend raises, generally speaking, you should be fine for the long term.

4. Be ready to buy when things are bleak

It takes a lot of guts to buy stocks when it feels like the market is falling apart, but that’s how the biggest gains are made. Whether you’ve raised capital by selling stocks whose stops were hit, or you have money set aside, buy stocks after a market slide. You might not catch the bottom, but since stocks go up over the long haul, getting them at a discount will add significantly to your returns. Regardless of the predictability of the magazine cover theory or any other signal, long-term investors should not get caught up in the day-to-day market noise. You will make money as long as you don’t panic in the face of a sell-off.

Marc Lichtenfeld is a senior analyst at Investment U. See more articles by Marc here. - See more at: http://www.hcplive.com/physicians-money-digest/personal-finance/Four-Steps-to-Prepare-for-a-Market-Crash-IU#sthash.jGTxbsF7.dpuf

Friday 16 December 2011

Sharemarket crash survival guide



Shares are being trashed, again. The temptation is to sell everything and run for the hills. Instead, take a chill pill and consider The Motley Fool’s patented sharemarket survival guide.
Down down, shares are going down.
After weeks of worrying about European sovereign debt woes, focus has again turned back to the U.S. and its own debt crisis.
In the U.S, the S&P 500 has posted its worst losing streak in 2 months.
Over the last 3 weeks, our own S&P/ASX 200 index has fallen almost 7 per cent in the last 3 weeks. Some shares have fared even worse…
Company% Share Price Fall Oct 28 2011 to Nov 21 2011
Australia & New Zealand Banking Group(ASX:ANZ)(10.6)
National Australia Bank (ASX:NAB)(10.7)
Iluka Resources Ltd. (ASX:ILU)(11.3)
Incitec Pivot Limited (ASX:IPL)(12.5)
Lend Lease Group (ASX:LLC)(11.2)
Mesoblast Limited (ASX:MSB)(14.1)
David Jones Ltd. (ASX:DJS)(13.1)
BlueScope Steel (ASX:BSL)(29.5)
White Energy (ASX:WEC)(72.4)
With the exception of White Energy, these are all big companies. It has been a tough time for investors.
So what are the keys to surviving market downturns? Here are some suggestions:
1. Don’t get absorbed in despair and panic. Ignore the violent emotional swings, and instead simply maintain a degree of detachment with regard to the whole business.
2. Be a regular saver and investor. That way, a market downturn becomes nothing more than a buying opportunity.
3. Reflect that Anne Scheiber, the U.S. lawyer who invested $5,000 in 1944 and died in the mid-1990s worth over $20 million, never sold a share and invested only in common, easily understandable companies. To her, we must presume, market fluctuations were an irrelevancy.
4. Finally, stop buying the newspapers, don’t watch the TV and go away on holiday. In short, switch off the market. Life’s too short for all that hullabaloo.
(As an aside, if you are worried about the market crash, you might want to first check out our new free report, Read This Before The Market Crashes. It could save you hours of heartache, and thousands of dollars. Click here to request your report now, whilst it’s still free and available.)
As our Investment Analyst Dean Morel said just a couple of weeks ago…
“When bearish volatility, caused by emotions and a lack of reason, leads humans to herd, sharemarkets become irrational and oversold. That irrationality allows investors who are able to control their emotions and act in a calm, balanced manner, to take advantage of the many opportunities the market throws up.
There is no need to make big decisions. You don’t  need to be fully invested in, or totally out of the market. Gradually building positions in the best companies while maintaining a cash cushion will make investing easier and less stressful.”
Stock market falls are like the seasons of the year. They are a natural part of the investment landscape, they are normal and can even be very healthy.
This latest crisis, like all crises before, will pass. And those that survive will prosper.

Thursday 6 October 2011

Connecting Crashes, Corrections And Capitulation

Connecting Crashes, Corrections And Capitulation

Posted: Jul 30, 2010

James Hyerczyk

Investors and traders face many obstacles in their quest for profits. Throughout even the longest uptrends, investors experience declines against the main trend. These are referred to as corrections. At other times, markets correct more than expected in a short period of time. Such occurrences are called crashes. Both of these can lead to a misunderstood situation called capitulation. We’ll look at these three concepts, their connections and what they mean for investors. (To learn more about market direction, read Which Direction Is The Market Heading?)

Wall Street’s White Flag
In stark terms, capitulation refers to market participants' final surrender to hard times and, consequently, the beginning of a market recovery. For most investors, capitulation means being so beaten down that they will sell at any price. True capitulation, however, doesn’t occur until the selling ends.

When panic selling stops, the remaining investors tend to be bottom fishers and traders who are holding on for a rise. This is when the price drop flattens into a bottom. One problem with calling the bottom is that it can only be accurately identified in hindsight. In fact, many traders and value investors have been caught buying into false bottoms only to watch the price continue to plunge - the so-called falling knife trap. (Traders can try to trade this phenomenon. Check out Catching A Falling Knife: Picking Intraday Turning Points for more.)

Capitulation or Correction?
When and where a market should bottom is a matter of opinion. To long-term investors, the series of retracements inside of a long-term uptrend are referred to as corrections in a bull market. A bottom is formed after each correction. Each time the market forms a bottom in an uptrend, the majority of investors do not consider it capitulation, but a corrective break to a price area where investors want to reestablish their long positions in the direction of the uptrend. Simply put, early buyers take profits, pushing the stock low enough to be a value buy again.

An investor can tell a correction from capitulation only after the trend has turned down and the downward break has exceeded the projected support levels and established a new bottom from which to trend up again. The question should not be whether capitulation is taking place, but whether the market has, in fact, bottomed.

Connecting to Crashes
A crash is a sharp, sudden decline that exceeds previous downside price action. This excessive break can be defined in real dollars as a market percentage or by volatility measures, but a crash typically involves an index losing at least 20% of its value. (To learn more, read The Crash of 1929 – Could It Happen Again?)

A crash is distinct from capitulation in two important ways. First, the crash leads to capitulation, but the time frame of the actual crash doesn’t necessarily mean capitulation will follow immediately. A market may hit capitulation – and the bottom – months after the initial crash. Second, a crash will always end in capitulation, but not all capitulations are preceded by a market crash.

In the long view, a crash occurs when there are substantially more sellers than buyers; the market falls until the there are no more sellers. For this reason, crashes are most often associated with panic selling. Sudden bearish news or margin call liquidations contribute to the severity a crash. Crashes usually occur in the midst of a downtrend after old bottoms are broken as both short sales and stop-loss orders are triggered, sending the market sharply lower. Capitulation is what comes next. (Learn more about buying on margin and margin calls in our Margin Tutorial.)

Finding the Bottom
A bottom can occur in two ways. Short selling can cease or a large buyer can emerge. Short sellers often quit shorting stocks when the market reaches historical lows or a value area they have identified as an exit point. When buyers see that the shorting has stopped, they start chasing the rising offers, thereby increasing a stock's price. As the price begins to increase, the remaining shorts start to cover. It is this short covering that essentially forms the bottom that precedes an upward rally.

As mentioned, the emergence of a large buy order can also spook shorts out of the market. It is not until the trend turns up, however, that one can truly say that buyers have emerged and capitulation has taken place. Large buyers occasionally try to move the market against the fundamental trends for a variety of reasons, but, like Sisyphus and his boulder, their efforts will fail if the timing is wrong. In timing capitulation, investors have to choose between going long on a rally started by short-covering or getting back in when actual buying – and the bottom – has been established. (For more, see Profit From Panic Selling.)

Catching the Turning of the Trend
Technical analysis can help determine capitulation because subtle changes in technical indicators such as volume are often heavily correlated with bottoms. A surge in volume is an indicator of a possible bottom in the stock market, while a drop in open interest is used in the commodity markets. Trend indicators such as moving average crossovers or swing chart breakouts are ways that chart patterns can help identify when a bottom or a change in trend has taken place.

Tricky Terminology
Crashes and capitulations are most often associated with equities, and the language is slippery. If we use percentage moves to determine whether a crash or capitulation has taken place in the stock market, then why is a downward move of over 20% in the commodities market always called a correction rather than a crash?

Moreover, one market event can also act as a crash, correction and capitulation. For example, a gradual break from 14,000 in the Dow Jones to 7,000 can be called a 50% correction of the top, but if the market drops the last 2,000 points in a short period of time, it will be called a crash. If the Dow then makes a bottom at 7,000, it will be called capitulation.

Real-World Crashes and Capitulations
Good historical examples are the Black Mondays of 1929 and 1987. In both cases, investors ran for the exits, producing big market drops. In 1929, the drop was prolonged as bad economic policies aggravated the situation and created a depression that lasted until World War II. The crash occurred in 1929, capitulation occurred in 1932, and then the actual rally occurred despite the economic conditions at the time. (For more, see What Caused The Great Depression?)

In 1987, the drop was painful, but stocks started to climb within the next few days and continued until March 2000. Surprisingly, the sudden drop in the stock market in October 1987 was called neither a capitulation nor a crash. Other euphemisms such as "correction" were used at the time. While some people realized what had occurred, it took the media years to label the event correctly. (For related reading, check out October: The Month Of Market Crashes?)

Bottom Line
After studying price movement, one can conclude that crashes and capitulation are parts of the same process. When a bottom occurs, traders can buy into the uptrend and watch the new support and resistance zones form as they navigate the rally until the next downtrend. So for them, it represents an opportunity. Long-term investors can also benefit from capitulation by getting into value stocks at extremely low prices. So, even though crashes, corrections and capitulations are bad news for investors holding the stock, there are still ways to profit. (Should you get out of a stock after a drop? Read When To Sell Stocks and To Sell Or Not To Sell for more.)

by James Hyerczyk
James A. Hyerczyk is a registered commodity trading advisor with the National Futures Association. Hyerczyk has been actively involved in the futures markets since 1982 and has worked in various capacities within the futures industry, ranging from technical analyst to commodity trading advisor. Using Gann theory as his core methodology, Hyerczyk incorporates combinations of pattern, price and time to develop his daily, weekly and monthly analysis. Hyerczyk is a member of the Markets Technicians Association and holds a master's degree in financial markets and trading from the Illinois Institute of Technology.


Read more: http://www.investopedia.com/articles/analyst/080702.asp#ixzz1ZzbPyTOR

Sunday 28 August 2011

Benefiting from Investor Over-reaction in major market crisis

Many investors overreact during times of crises. Retail investors especially tend to panic and sell out at the bottom and then buy at the top when the market rebounds. The fear of losing out on a rally and recoup some of their losses forces them to act this way. This classic scenario occurred in the aftermath of the recent financial crisis.After seeing their portfolio values decline consistently for many months some investors threw in the towel and sold out right when the market was hitting the lows in March 2009. These investors couldn’t be more wrong. From the lows of March 10, 2009 the S&P 500 rallied a spectacular 80% by April of 2010. The moral of the story here is that investors should not panic and sell out when the market is already down significantly. The market rewards patient investors who hold investments for the long-term as opposed to trying to time the market in the short-term for a quick profit.

In general, how does the markets perform post major crises?
The chart below shows the 1-year and 2-year returns of Dow Jones Industrial Average(DJIA) after 12 major post-war crises:






The returns assume reinvestment of dividends and distributions. Similar to the S&P 500, the Dow Jones Index gained 65% and 95% in 1 year and 2 years respectively after the 2008-09 global financial crisis. Overall the index was up by double digits in the periods mentioned after each of the crises shown in the chart above.

http://topforeignstocks.com/2011/06/25/stock-market-performance-post-major-crises/

Tuesday 15 February 2011

If stock markets or stocks crash, WHO will benefit the most?

Those who bought during bubbles become paupers during crashes.

Those who bought during crashes become millionaires when the market reverses.

Wealth is destroyed by bubbles and created from crashes.

Your potential returns are a function of price you paid for the stocks offered by the market.

Those who will be investing for a long time will like the stock market when it is on CHEAP SALE.

Those who need to cash out significantly for various reasons during crashes will be the losers.

Sunday 9 May 2010

The FAT FINGER Incident. Why the market crashed on 6th May 2010?

So what happened? Details were still fuzzy last night as of this writing, but it looks like the event will become known as the fat finger event. A trader at Citi entered an order to sell 15 million shares of a security (not an outrageous amount), but accidental typed billion. Traders all over the globe saw the huge sell order and followed suit assuming Citi knew something. A massive selloff ensued. Part of the issue is because a lot of sophisticated traders use stop-loss order to limit themselves from losing too much in a massive selloff. Say I owned stock in Google and wanted to protect myself from losing too much money if the stock lost value. Earlier this week Google was trading around $530. So maybe I decided if the price dropped to $500 I’d sell my position. When the massive selloff occurred Google dropped to $500 so my stop loss order was triggered. All over the world millions of stop-loss orders like this were triggered so the market was flooded with sell orders and the price of everything tanked. Though it was fantasy trading, I had quite a few stop loss orders triggered as well.

In the high paced world of trading, with lightning fast computers, and herd mentalities, in a matter of minutes almost 10% of the value of the US stock market was wiped out. This 2.5 minute video shows how quickly it happened, and makes Jim Cramer look like the savior of the market. He literally calls the selloff ridiculous, and then people just started buying.
















The FAT FINGER Incident

Sunday 18 October 2009

The Ten Biggest Stock Market Crashes of All Time

April 14, 2008
The Ten Biggest Stock Market Crashes of All Time




Some investors might think they have had a rough ride on the stock market over the past seven or eight months. But the recent share price gyrations pale into insignificance when compared with the biggest stock market falls of all time.

10) Wall Street 1901-03: -46%
The market was spooked by the assassination of President McKinley in 1901, coupled with a severe drought later the same year.

9) Wall Street 1919-21: -46%
There were fears that the new automobile sector was becoming overheated and that car ownership had reached saturation point.

8) Wall Street 1906-07: -48%
Markets took fright after President Theodore Roosevelt had threatened to rein in the monopolies that flourished in various industrial sectors, notably railways.

7) Wall Street 1937-38: -49%
This share price fall was triggerd by an economic recession and doubts about the effectiveness of Franklin D Roosevelt's New Deal policy.

6) London 2000-2003: -52%
The UK took sixth place in the table with a 52 per cent market fall between 2000 and 2003 as investors suffered the consequences of the collapse of the technoogy bubble

5) Hong Kong 1997-98: -64%
The Hong Kong stock market’s heavy fall in 1997-1998 came as investors deserted emerging Asian shares, including a very overheated Hong Kong stock market

4) London 1973-74: -73%
Next came the UK stock market’s 73 per cent drop in 1973 and 1974. set against the backdrop of a dramatic rise in oil prices, the miners’ strike and the downfall of the Heath government.

3) Japan 1990-2003: -79%
In third place, with a 79 per cent decline, was the Japanese stock market, which suffered a protracted slide in price from 1990 to 2003 as a share and property price bubble burst and turned into a deflationary nightmare.

2) US Nasdaq 2000-2002: -82%
The second biggest collapse came from the technology-rich US Nasdaq index, which fell by 82 per cent following the bursting of the dot.com bubble in 2000

1) Wall Street 1929-32: -89%
The Wall Street Crash heads the list, with the US stock market falling by 89 per cent between 1929 and 1932. The bursting of the speculative bubble led to further selling as people who had borrowed money to buy shares had to cash them in in a hurry when their loans wre called in.

David Shwartz, the stock market historian, says: “The very big stock market crashes are invariably triggered by a series of different events which unfold one after the other. For example the biggest UK stock market slump in 1973-74 was started by the fear of stagflation, but was then fuelled by the dramatic rise in oil prices of late 1973, followed by the Miners’ strike and the downfall of the Heath government. One heavy blow is not enough to produce a market crash. It requires several different blows to bring a market to its knees.”

(This list only includes stock market crashes in industrialised economies.)

http://timesbusiness.typepad.com/money_weblog/2008/04/the-ten-biggest.html

Saturday 8 November 2008

7 Lessons To Learn From A Market Downturn


7 Lessons To Learn From A Market Downturn
by Stephanie Powers (Contact Author Biography)

You can never really understand investing until you weather a market downturn. The valuable lessons learned can help you through the bad times and can be applied to your portfolio when the economy recovers. Listed below are some common investor experiences during tough economic times and the lessons each investor can come away with after surviving the events.


Lesson #1: Evaluate Your Egg Baskets

You're pulling your hair out because everything you invest in goes down. The lesson: Always keep a diversified portfolio, regardless of current market conditions.

If everything you own is moving in the same direction, at the same rate, your portfolio is probably not well diversified, and you could stand to reconsider your asset-allocation choices. The specific assets in your portfolio will depend on your objectives and risk-tolerance level, but you should always include multiple types of investments. (Read Personalizing Risk Tolerance to find out how much uncertainty you can stand.)

Taking a more conservative stance to preserve capital should mean changing the percentages of holdings from aggressive, risky stocks to more conservative holdings, not moving everything to a single investment type. For example, increasing bonds and decreasing small-cap growth holdings maintains diversification, whereas liquidating everything to money market securities does not. Under normal market conditions, a diversified portfolio reduces big swings in performance over time. (For more information, read Diversification: It's All About (Asset) Class.)


Lesson #2: No Such Thing As A Sure Thing

That stock you thought was a sure thing just tanked. The lesson: Sometimes the unpredictable happens. It happens to the best analysts, the best fund managers, the best advisors, and, it can happen to you.

The perfect chart interpretation, fundamental analysis, or tarot card reading won't predict every possible incident that can impact your investment.

  • Use due diligence to mitigate risk as much as possible.
  • Review quarterly and annual reports for clues on risks to the company's business as well as their responses to the risks.
  • You can also glean industry weaknesses from current events and industry associations.
More often, an investment is impacted by a combination of events. Don't kick yourself over unpredictable or extraordinary events like supply-chain failures, mergers, lawsuits, product failures, etc. (Learn how to find companies that manage risk well in The Evolution Of Enterprise Risk Management.)


Lesson #3: Proper Risk Management

You thought an investment was risk-free, but it wasn't. The lesson: Every investment has some type of risk.

You can attempt to measure the risk and try to offset it, but you must acknowledge that risk is inherent in each trade. Evaluate your willingness to take each risk. (See Measuring And Managing Investment Risk for information on keeping necessary risk under control.)


Lesson #4: Liquidity Matters

You always stay fully invested, so you miss out on opportunities requiring accessible cash. The lesson: Having cash in a certificate of deposit (CD) or money market account enables you to take advantage of high-quality investments at fire sale prices. It also decreases overall portfolio risk.

Plan ahead to replenish cash accounts. For example, use the proceeds from a called bond to invest in the money market instead of purchasing a new bond.Sometimes cash can be obtained by reorganizing debt or trimming discretionary spending. Set a specific percentage of your overall portfolio to hold in cash. (Learn how to take advantage of the safety of the money market in our Money Market tutorial.)


Lesson #5: Patience

Your account balance is lower than it was last quarter, so you overhaul your investment strategy before taking advantage of your current investments. The lesson: Sometimes it takes the market an extended period of time to bounce back.

Your overall portfolio balance on a given date is not as important as the direction it is trending and expected returns for the future. The key is preparedness for the impending market upturn based on an estimated lag time behind market indicators. Evaluate your strategy, but remember that sometimes patience is the solution. (Doing nothing can mean good returns. Find out more in Patience Is A Trader's Virtue.)


Lesson #6: Be Your Own Advisor

The market news gets bleaker every day - now you're paralyzed with fear! The lesson: Market news has to be interpreted relative to your situation.

Sometimes investors overreact, particularly with large or popular stocks, because bad news is replayed continuously via every news outlet. Here are some steps you can follow to help you keep your head in the face of bad news:

  • Pay attention and understand the news, then analyze the financials yourself. (Read What You Need To Know About Financial Statements for help.)
  • Determine if the information represents a significant downward financial trend, a major negative shift in a company's business, or just a temporary blip.
  • Listen for cues the company may be downgrading its own expected returns. Find out if the downgrade is for one quarter, one year or if it is so abstract you can't tell.
  • Conduct an industry analysis of the company's competitors.

After a thorough evaluation, you can decide if your portfolio needs a change. (For more information, read Do You Need a Financial Advisor?)


Lesson #7: When To Sell And When To Hold

The market indicators don't seem to have a silver lining. The lesson: Know when to sell existing positions and when to hold on.

Don't be afraid to cut your losses. If the current value of your portfolio is lower than your cost basis and showing signs of dropping further, consider taking some losses now. Remember, those losses can be carried forward to offset capital gains for up to seven years. (For more information, read Selling Losing Securities For A Tax Advantage.)

Selective selling can produce cash needed to buy investments with better earnings potential. On the other hand, maintain investments with solid financials that are experiencing price corrections based on expected price-earnings ratios. Make decisions on each investment, but don't forget to evaluate your overall asset allocation. (Read more in Asset Allocation: One Decision To Rule Them All.)


Conclusion

Downward stock market swings are inevitable. The better-prepared you are to deal with them, the better your portfolio will endure them. You may have already learned some of these lessons the hard way, but if not, take the time to learn from others' mistakes before they become yours.

Read Adapt To A Bear Market to learn how to structure your portfolio to withstand tough economic times.

by Stephanie Powers, (Contact Author Biography)

Stephanie Powers has worked in the financial services industry since 1995. She uses her experience as a financial advisor to write investment and personal finance articles that educate readers and help them make informed decisions. Her credentials include FINRA securities licenses, an MBA, and experience consulting with individuals and businesses for Edward Jones Investments and Merrill Lynch. Previous experience includes working as a business consultant for American General Insurance and IBM.In her spare time, Stephanie enjoys traveling, playing golf, and genealogy research.

** This article and more are available at Investopedia.com - Your Source for Investing Education **
http://www.investopedia.com/articles/basics/08/lessons-market-downturn.asp?partner=basics