Monday, November 10, 2008

Five things you should avoid in a bear market

Now that the last of the disbelievers has given up hope, we should have no further doubts that we are in the midst of a raging bear market. So what does a smart investor do in this situation? Avoid making a bad situation even worse.

1. Don't Panic: One can well understand that you may be losing sleep if you entered the market in late 2007 or early 2008. You must be facing serious losses. But do not panic. The world has not come to an end. Your loved ones still love you. And unless you are overleveraged, you will eventually get out of this tough  situation, and hopefully, learn from it.

2. Don't Average down: Just because you had bought stocks at higher prices, you may be tempted to lower your average price per share by buying at lower prices now. That will be like throwing good money after bad, as you may be turning a smaller loss into a much bigger one. No one knows how much lower the market or individual stocks may go, and how long they will stay there.

3. Don't Buy on rallies: Bear market rallies are usually sharp and swift. But bear markets do not provide great entry points, because it is difficult to call a bottom. (Bull market corrections provide better entry points.) You make money in a bear market by selling short. I'm not advocating short selling for small investors because it is a risky proposition for the inexperienced. But bear market rallies can, and should, be used for disposing off non-performing stocks.

4. Don't Buy second or third rung stocks: They may appear cheap and a bargain. But such stocks get even cheaper, that is, if they manage to survive at all. Remember, if you bought a stock that has fallen 50% and now looks cheap, it will need to rise 100% just to get back to its earlier price.  When the next bull market begins, the market leader stocks will be at the forefront of the up move.

5. Don't Trust the media: They broadcast or write what they think will 'sell', and therefore get market situations all wrong. If you have been hearing (or reading) of late that the market has capitulated and we are close to a bottom, chances are that the market will fall some more. Bear markets come to an end when every one has lost all interest in what is happening in the markets.

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