The past 7 days have taught us a good lesson regarding risk management. The Dow Jones Industrial Average dropped to a low last week for the year of 15,855. The correction that started in September reached its peak last week. The correction finished at 9.8% in four weeks. There were many scares in the headlines (e.g., Ebola, international economic woes, Isis, etc.) Fear was at a high for the year, especially last Wednesday when the Dow was down more than 450 points. As of this writing, the DOW is currently trading at 16,710. This represents a swing of 855 points in a week. Did you stay the course? Should you stay the course? What has really changed today vs. what was going on last week? What actions, if any should you now take? Was the September/early October correction a precursor to future declines ahead?
Many times investors do not recognize their personal tolerance for risk until they experience a loss in value due to a significant correction. Some remember the past, and it can cause them to take less risk than they should; others forget the past and continue making the mistakes (adding too much risk long after the market has had a significant gain to the upside). Experience leads me to believe there are 3 styles of investors – the goal minded investor, the aggressive/trader investor, and the concerned investor. When markets are stable, these three styles go dormant. When we have times of stability, emotions relating to investing money are stable. When markets become volatile and have quick corrections, these three styles tend to manifest. As I have said to many people over the past 15 years, when you make decisions based on emotion, they typically don’t go well. How you felt last week should define how you manage your money (or should help you to understand your tolerance for risk better). If you are a concerned investor, it may be time to evaluate the risk you have in your portfolio given that we have regained much of what were losses the past four weeks. The goal-minded investor should continue to monitor his individual goals and evaluate his portfolio to make sure it still fits with his goals. The aggressive/trader, although rare in today’s market environment, most likely bought some stock last week, and is now looking to sell. Remember history and lessons from the past and understand your risk tolerance. These are key to achieving continued success and to help you get through turbulent times.
So, where are we based on my discussion last week of a “dead cat bounce” and how bear markets develop? I reported that bear markets typically have an initial warning, and the past five warnings going back forty years have averaged 10.3%. This past correction was 9.8%. I reported that the markets on average regain 78% from the initial drop. If this was a warning, the stock market would start to turn down by early November. I will report next Friday about the probability of another correction in November. I have said that volatility is a sign of market weakness. I would rather the DOW be up 50 points vs. up 250. The DOW being up 250 is nice; however, given past history, bear market rallies are volatile and straight up, which so far is how this rally has been.