Sane Investing Stratagies for This Insane Market
Talk about volatility. Since the beginning of October, there has been only a single trading day where the market has not swung at least 1% between its low and high points. The most stomach-churning day was Oct. 4, when the low-to-high swing was an astounding 4.7%.
This is the kind of volatility that Benjamin Graham -- the man who taught investing to Warren Buffett -- described as making the stock market "an emotional wreck." For an unprepared investor, a market like this can cause a normally reasonable person do serious damage to their long-term wealth.
A rapidly rising market sings a siren song of "buy now or risk missing out," luring many investors into the type of "buy high and sell low" activities that quickly separate them from their money. Like the sirens of Greek legend, those who fall prey to that seductive song can quickly find their wealth destroyed when the market changes course and falls just as quickly.
On the flip side, putting money into a quickly dropping market may seem a bit crazy, too. After all, an insanely falling market won't just take down one or two stocks with it. When the market absolutely tanks, it has a habit of throwing the babies out along with the bathwater, and no stock is completely safe from its wrath.
Opportunity Still Knocks
Yet it's exactly the times like that when the best opportunities are made available -- the chance to do what investors like Buffett would call "buying great companies at good prices."
Doing that well isn't rocket science, but it does require separating what the market thinks about the stock at this very moment from what the company behind that stock is really worth.
There are dozens of different methods of valuing companies to figure out what they're really worth. While each method has its plusses and minuses, they all share a common flaw: They're trying to predict the future. While you can get to a fairly decent prediction much of the time, you're never going to get that future exactly perfect.
So instead of trying to drive yourself crazy trying to chase a perfect model and value, you're really better served by figuring out what "close enough is good enough" looks like. With that "close enough" view, you can use time-tested investing tactics that will let you survive -- or even thrive -- in this insane market.
Straightforward Tactics for Ordinary Investors
There are two tactics that work well for individual investors, by virtue of the fact that they don't require any sort of supernatural future prediction capabilities or massive sums of money to execute.
• Dollar-cost averaging: This tactic simply has you invest the same dollar amount every month in a company you want to buy. When the stock is cheap, your dollars buy more shares, and when the stock is expensive, your cash buys fewer. Since you can't predict the future perfectly, and since the market is essentially guaranteed to knock your stocks for a loop, it gives you a good way to buffer out the impact of those wild swings.
Knowing that your next buy will likely get you more shares of a company that just dropped can take the edge off the paper loss you're feeling by holding during that drop. Likewise, knowing that you're getting the benefits of owning before a significant rise in price can take some of the sting out of realizing that your next buy might be for fewer shares at a higher price. As the chart below shows, there's enough volatility even in well known stocks for the tactic to make a difference for a $200 a month investor:
$200 Bought X Number of Shares at Low
$200 Bought X Number of Shares at High
Cisco Systems (CSCO)
General Electric (GE)
L-3 Communications (LLL)
• Limit orders: This second tactic takes a bit more patience and doesn't guarantee you'll actually buy or sell the stocks you're considering. But it does guarantee that if a transaction happens, you'll pay no more than your limit price to buy and get no less than your limit price to sell. After all, that's exactly what a limit order is: an agreement to buy a stock at or below a certain price or to sell it at or above a price. And as the investor placing the order, you get to choose that price.
Of course, there's no guarantee that the market will cooperate and give you that price. But if you set your limit prices based on your best estimate of what that company is worth, you'll protect yourself from egregiously overpaying in a bull market or panic selling into a bear one.
Either one of those tactics -- or a combination of both -- should help you keep your investments sane, no matter how crazy the market gets.
At the time of publication, Motley Fool contributor Chuck Saletta owned shares of Cisco Systems and General Electric. Click here to see his holdings and a short bio. The Motley Fool owns shares of Ford, Cisco, and L-3 Communications, as well as a bull call spread position on Cisco. Motley Fool newsletter services have recommended buying shares of L-3 Communications, Ford, and Cisco.