6 Bear Market Traps and How to Avoid Them
April 13th, 2009 at 1:00pm by Tom Lydon
Emotions can be our own worst enemy when it comes to exchange traded fund (ETF) investing, and bear markets can heighten them. But there are ways to avoid the traps that have sunk many a portfolio.
Suzanne McGee for The Wall Street Journal says that falling into traps in bear markets is easy. Our fears and emotions are heightened. Big losses tend to be seen, especially in the current bear market, leading to “desperation” moves. Some investors get so scared, they don’t do anything.
1. The Value Trap. Investors convince themselves that a stock or ETF makes sense because it’s cheap, making it a great value. But sometimes “cheap” can mean “trouble.” Examine the fundamentals of a sector instead before deciding that something is a bargain.
2. The Risk Trap. The urge to recoup losses can lead some investors to make outsize bets on narrow ETFs or within volatile sectors. Instead of taking big risks, experts suggest sticking to the basics: staying diversified and building returns steadily through compound interest and dividends.
3. The Scapegoat Trap. Everyone’s looking for someone to blame for the losses, but don’t forget that nearly everyone is in the same boat no matter who is managing their money.
4. The Paralysis Trap. Many investors are now too scared to move at all. They either are scared to sell off holdings to limit losses, or they’re too scared to get back in when there are signals that suggest it could be an opportunity. If you’ve hit a buy signal, you may find it helpful to research the fundamentals of your position. This may make it more comfortable for you to take a position and help you overcome your paralysis.
5. The Comfort Trap. Wall Street likes to promise safety with certain products when investors get especially fearful, but there can be a downside. Sometimes these products come in the form of big fees or they can limit your upside potential. Bear in mind that to get some return, there has to be some risk.
6. The Chasing-the-News Trap. It’s tempting to react to each and every little turn the market takes, especially if you’ve got the television tuned to a financial news network all day long. How can you avoid these reactions? By having a strategy and sticking to it. We use the 200-day moving average to decide when we’re in and out. While the day-to-day news can be interesting and helpful, the 200-day is the signal we rely on.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.