This Secret Will Make You Immune to the Market's Meltdown

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There's really only one thing you need to do if you want to be immune to the market's volatility. And it's far simpler than you think.

But in order to fully appreciate what this secret is, I want to draw upon a story that will help highlight my point.

A lesson from Lancelot
In the cheesy Richard Gere movie First Knight, there's a scene where an onlooker asks Lancelot what his secret to being a master dueler is. Gere's answer:

  • Figure out how your opponent thinks.
  • Strike hard during the make-or-break moment in the battle.
  • Don't care about living or dying.

Obviously, the onlooker understands the first two secrets well, but the third is tough to swallow.

Translated to investing
Putting aside for the moment the source of the metaphor, there are some key lessons here.

  • While most of the market buys stocks based on short-term movements, Foolish investors should be long-term, buy-and-hold investors.
  • Be greedy when others are fearful, and fearful when others are greedy.

The first two points, respectively, are easy to translate, but the third one demands an explanation.

For that, I look to Dan Ariely's The Upside of Irrationality. In it, he makes the simple point that when stakes are high -- and stress is, too -- we are far more likely to screw up tasks that require our focus. And if the past few years have taught us anything, it's that investing requires a great deal of focus.

Knowing this, Lancelot's lesson is easier to swallow: If a dueler isn't worried about whether he lives or dies, he is free from distraction and is guaranteed to strike at the critical moment in the fight.

This, of course, leads to the secret this article is all about: If you aren't worried about whether you gain or lose money in the stock market, you're far more likely to make profitable decisions in a cool, calm, and collected state.

Reaching that Zen place
As preposterous as it sounds, it's actually very easy to get yourself to a place where you can approach investing from such a detached viewpoint. I can think of four steps right now that'll help get you there.

  1. Pay off debt -- Especially the high-interest, credit-card-type debt that can follow you around for years.
  2. Build up an emergency fund -- This should be large enough to cover all of the expenses for you and your dependents should you lose your income for at least six months.
  3. Plan for big purchases -- Should you have any major expenses that you can foresee on the three-year horizon, keep that money in a high-yield savings account.
  4. Live below your means -- By setting yourself up to have reasonable expectations, you'll not only save money, but probably spend more time focused on life's most important matters.

Only after these four steps have been accomplished should you be investing money in stocks. Knowing that all of your needs will be met regardless of what the market does, you'll be able to make your decisions from a calm, rational place.

Putting things in perspective
I think fellow Fool Jeff Fischer put it best when he wrote:

You don't want your main focus during your time here to be money. You want your finances to be sensible, sustainable, provide for you and your family, and not worry you much. Period.

Taking this approach, I've tried to identify six companies whose shareholders are currently acting in a very un-Zen-like manner. Though earnings have been improving for all of the companies mentioned, the current market volatility has allowed their share prices to fall off a cliff.

Company

1-Month Return

What It Does

Why the Fall?

Zhongpin (NAS: HOGS) (19%)Meat and food processing in ChinaUnresolved allegations of fraud.
Riverbed Tech (NAS: RVBD) (42%)Appliances that speed up information flow across networksMerely met earnings expectations rather than beating.
Teva Pharmaceutical (NAS: TEVA) (22%)Generic drugsWeak U.S. sales; lawsuit from pharma competitors.
Panera Bread (NAS: PNRA) (24%)Fast-casual diningDisappointing guidance.
Acme Packet (NAS: APKT) (32%)Delivery of communication via InternetSky-high P/E in volatile market.
F5 Networks (NAS: FFIV) (35%)Improve performance of Internet applicationsBeat earnings expectations, but investors wanted an even bigger beat.

Source: Yahoo! Finance as of Aug. 10.

By clicking on the last column, you can read that other Fools aren't really worried about the recent downturn of these companies either.

You won't find a link for Acme, which in my opinion doesn't have a rock-solid reason for its downturn. During times of heavy market volatility, however, it's common to see stocks with high P/Es go up and down much quicker than the market in general. I have a feeling that helps account for Acme's recent slide.

Zhongpin, on the other hand, seems to be just one of the many small-cap Chinese stocks that can run up and down on a moment's notice when a blog comes out accusing fraud. The company vehemently denies any wrongdoing.

One more idea for Zen masters
All six of the companies listed have traded in a wide range lately, and it's likely that investors have sold off based in part on fear. Of course, you need to do your own research to determine if any of these stocks are right for your portfolio.

If you're looking for another interesting idea, I encourage you to look at a brand new special report out from The Motley Fool: The Hottest IPO of 2011. Inside, you'll find out about a stock that promises to deliver amazing long-term returns. It's yours today, absolutely free!

At the time this article was published Fool contributor Brian Stoffel is spending his time outside today. He does not own shares in any of the companies mentioned. The Motley Fool owns shares of Teva Pharmaceutical Industries. Motley Fool newsletter services have recommended buying shares of Teva Pharmaceutical Industries, Panera Bread, Acme Packet, and Riverbed Technology. Motley Fool newsletter services have recommended writing puts in Zhongpin. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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