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 How to Panic Well

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Number of posts : 440
Registration date : 2007-07-01

PostSubject: How to Panic Well   Wed Aug 29, 2007 10:57 pm

How to Panic Well

By John Rosevear
August 29, 2007


quick search for the word "panic" on one of my favorite financial news
sites turns up almost 700 hits, many of them recent. "Avoid the Panic
Room," "Panic in the Crude Pits," and "Positioning Yourself in the
Current Market Panic" are just three of many recent articles that ran
on this particular site. Search engines confirm that "panic" is a
consistent theme across the major financial media at the moment, with
thousands of recent hits.
Now, personally I'm inclined to think that Rule No. 1 of long-term investing is "don't panic, ever." As I've written in the past, following the herd -- especially when it panics and stampedes -- can lead to big losses during times of market turbulence that aren't directly related to your investments' fundamentals.
But some will insist on panicking anyway. Loss aversion -- the idea
that people feel the pain of losses much more acutely than they feel
the joy of equivalent gains -- is a well-demonstrated psychological
principle, and it drives people to sell otherwise good investments and
head for the hills when the market stumbles. If you're one of those
people who feels loss aversion strongly, and you're not interested in
working to overcome your impulse to panic and sell at the worst
possible time, then read on. After all, if you're going to panic, you
might as well do it right.

How to panic properly
As I see it, the three keys to proper investment panic are these:

  • Time your panic carefully. There's
    an old Wall Street saying: If you're going to panic, panic early. Like
    a lot of Wall Street sayings, it's often nonsense. If you had panicked
    and sold Amazon (NYSE: AMZN)
    early on in the summer of 2000, during the first downward leg of the
    bear market, you might have lost some money -- but you still would have
    received about $50 a share. It wasn't until April of this year that the
    stock got solidly back above that level. If, on the other hand, you had
    held on until right after the 9/11 attacks, you could have sold for $7
    a share. Now that's a satisfying panic sale.

  • Lose a lot of money. I'm
    not talking about 5% here, I'm talking about a nice big loss -- the
    kind you would have gotten with Amazon, or the one you could have had
    by buying General Motors (NYSE: GM)
    at $35 in the summer of 2005 and then selling at $18 six months later,
    right before the turnaround plan (the one management had been talking
    about for months) started to bear fruit.

  • Get a good story out of it. Selling Akamai (Nasdaq: AKAM) for $32 on its current dip, driven by fears about rising competitor Limelight (Nasdaq: LLNW),
    isn't much of a story -- that's just business. Selling Akamai (along
    with almost everyone else) at $0.90 after its founder died during the
    9/11 attacks, only to watch it recover? Now that's a story.

How not to panic
If the above
doesn't sound like much fun, you could always consider not panicking. I
personally recommend this approach. Here's how not to panic:

  • Remember that you're wired to worry. Downward
    swings in the market seem scary because of our natural tendency toward
    loss aversion -- and because they usually happen much more quickly than
    upward swings. The market may spend a year going up 25%, only to go
    down 10% in four or five days. Remember that that's just how the market

  • Focus on fundamentals, not day-to-day prices. If
    you're an investor, not a trader, there's no need to sweat normal price
    movements. The question isn't whether your stock is up today,
    it's whether it's up over a year or two -- and more importantly,
    whether the reasons that drove you to buy it in the first place are
    still valid. If the management remains sound, the price still seems
    cheap in light of fundamentals, and the business outlook still seems
    bright, why sell?

  • Take a vacation from market news. If
    you're not actively looking to make new investments (in which case it's
    a good time to be hunting for bargains), and the stress of the current
    market action is driving you nuts, turn off the news! Leave The Wall Street Journal
    unread. Resolve to ignore it, at least for a week or two. Remember that
    you haven't actually lost money if you haven't sold, and remember that
    markets have always recovered from dips and corrections.

The upshot is this: If the fundamentals of your investments remain
sound, don't sweat Mr. Market's gyrations. Turn off your computer, take
a deep breath, and go for a walk. Everything will still be there when
you get back. And whatever you do, don't panic!

Akamai is a
Motley Fool Rule Breakers
recommendation. For investing tips about the most innovative companies in business, take advantage of a free 30-day trial and see everything Rule Breakers has to offer. Amazon is a Stock Advisor pick.

Fool contributor [email]John Rosevear[/email] does not own any of the stocks mentioned above. The Motley Fool's disclosure policy never panics, but it does get a little twitchy from time to time.
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