Wednesday, January 23, 2008

A Stock Market Crash?

I know I promised a discussion of risk and volatility, but that will have to wait. The stock market is crashing! Shouldn’t we be doing something?

Yesterday morning the newspapers and online news sources were nearly unanimous: stocks are headed down and it’s going to be ugly. It can be tempting to sell everything at times like this, and many investors will sell.

But if you do sell, when will you jump back in? Maybe you’ll buy once the market rises consistently for a week or two to show that the carnage is over. But this amounts to selling low and buying high. This is the opposite of what you want to do to make money.

Any attempt to time the trading of stocks to make more money is called market timing. It can be tempting to try market timing, but be aware that there are others out there who are trying to beat you at this game.

Collectively, market timers can’t make more money than those who simply buy and hold their stocks. In fact, on average they have worse results because they have their money on the sidelines some fraction of the time and are losing out because the market rises most of the time.

To win at market timing, there have to be others who lose at market timing. It’s like playing poker: for there to be winners, there have to be losers. If you plan to try market timing, you have to ask yourself: am I better at this than other people are? If you prove to be an average or below average market timer, you will lose money.

As it happens, my own portfolio rose 3% yesterday. I’m not mentioning this to gloat; I could quite easily lose 5% today. The point is that the stock market will turn around eventually. It’s just that nobody knows for certain when this will happen.

You will be disappointed if you miss a significant jump in stock prices because you panicked and sold. Often the best thing to do is nothing, especially when our emotions are getting the better of us.

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