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You have to go back to the summer of 2008 to find the last time we saw shares of multi-billion dollar banks moving 20% of more and plumbing new lows -- as Bank of America (BAC), Citigroup (C), Goldman Sachs (GS), Sun Trust Banks and others have in recent days. Although the factors are different this time, the fallout is frighteningly familiar. Between the U.S. losing its Triple-A credit rating, failed yet increasing government intervention and the implosion of the European welfare state, there's little precedent on which traders can model the markets.
We might not be simply on the verge of a panic -- but rather in one as we speak, judging by the skyrocketing volume, volatility and 24/7 media coverage. Yesterday all three mainstream TV networks interrupted normal programming during the Dow's closing plunge -- the kind of attention that typically comes at the end of a big move, not the beginning.
The fear, however, isn't simply that of an economic slowdown -- investors and businesses can hedge that -- but rather a systemic breakdown, a Bear Stearns or Lehman-like disruption that once again brings the markets to its knees. During unquestionably trying times, when the market is diving and the world is panicking, the easiest thing in the world to do is join in. Resist that urge.
Panic is drive by emotion, not reason, making it by definition a bad state of mind for decision-making. Yet with the headlines and markets so undeniably bleak, it's difficult to see even slightly beyond the next press conference or market plunge.
It's well documented that investors feel the pain of losses much more than the euphoria of gains. And with the market having lost 15% in just two weeks, many frightened investors are likely wondering why they own stocks at all. Why not dump your entire stock portfolio and go out for ice cream? That's exactly the kind of all-or-none fallacy we buy into in the midst of a panic. You'll recall many worried investors liquidating whole portfolios in March of 2009, just as equities bottomed out.
Rather than emotionally jump from being heavily exposed to hiding under the mattress, investors are better served by a sell discipline based on the positions in their portfolio, not headlines on TV. That means holding onto open, winning positions while eliminating low probability trades, exactly as you would in a "normal" market. To dump your entire portfolio simply because it feels safe is as reckless as binging on a candy store's worth of sugar. Long term, neither is in your rational self-interest.
Another bad move: Trying to catch a falling knife in what still appears to be a waterfall of cutlery. As we always point out, one need not buy at the bottom of a move in order to make money. But panic is painful, and where investors hang themselves is by fighting the tape with huge positions in an attempt to "get back" to even. So when XYZ falls from $30 to $24, we foolhardily buy three times as much, wistfully hoping even a tiny bounce will remedy our discomfort. In reality, we're fighting the tape and using resources in what objectively looks to be a low probability trade.
Keep a list of top long ideas; mine includes exposure to the Indian rupee and Russian ruble, both of which I've profiled in recent weeks. But rather than trying to buy them on the way down, I wait for some indication they've again found their footing. If Orix (IX) is going to be a $57 stock again, it'll have to start by holding at $50. As accustomed as we are to wanting a bargain, I'd rather buy it higher.
In the midst of a storm, the lightning and thunder is downright terrifying. Yet fear can't be the basis on which we make decisions. When opting between following your emotions or your disciplined trading plan, stick with your plan. Panic can't go on forever, the storm eventually ends. This one will too.
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC. At the time of writing, Hoenig's Fund held positions in many of the securities mentioned.
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