Investing: Dow drops 2700 points It is a title that all the fears of investors in equity markets will happen. The market crash and their hard-earned nest egg evaporates. They are forced to return to work and have to resort to eating beans and rice. Is the fear justified? No.
Stock markets worldwide fell Tuesday. The news media reaction to it was the largest one-day fall since September 11th, 2001. The Chinese stock market fell nearly 10%. Here in the United States, the major indexes fell more than 3%. At one point the Dow Jones Industrial Average fell over 150 points in one minute!
Should investors panic? No, the world is not ending. The world's economies continue to be strong and are growing. Interest rates are still low by historical standards. And the decline yesterday after 7 months when markets recorded increases of 15%, 25%, 40% and even 77%.
Firstly, we must put down yesterday in a proper perspective. I remember the banner in 1987 when the stock market has fallen. This is something I will never forget and is one of the reasons I developed the systems and strategies I use to manage the money from my customers today.
On Tuesday, the Dow Jones Industrial Average fell a little over 400 points. To match the market decline in 1987, the total decline on Tuesday should be 2700 points. On Tuesday, the Dow dropped 3%. In 1987, it fell about 20%!
Secondly, there will be times when the markets make adjustments quickly. This is true not only for equity markets, but bond markets and real estate as well. The introduction of electronic commerce and the proliferation of hedge funds only add to instability.
That may be what happened yesterday. Hedge funds can be utilized as much as 30:1. This means that if they have a dollar, they borrow more than thirty dollars and invest it. If markets go up, a hedge fund can make enormous returns. If markets drop too much, then they get a "margin call". Then those who lent money decide they want to support it - immediately.
When trading on margin someone gets a margin call, the more often they have to sell investments to generate the cash needed to cover the call. When you're leveraged 30:1, meaning you have to sell a lot of investment. Hundreds of millions of dollars can be sold in minutes with the use of electronic commerce. That the sale on the market causes down, causing others to receive margin calls. So, they then have to sell.
Many managers of mutual funds today have not experienced a decline, as 1987 or 2001. Initially, they hang. But as the new bear market, they succumb to fear and decide to start dumping investments. In my opinion, is why the sale has accelerated Tuesday afternoon.
This brings me to my second point. Who's Watching Your Money? When things go wrong, they can go wrong in a hurry. This is why it is so important that you know there is someone who closely monitors your money and take the necessary steps to protect it.
Unlike most managers, I use multiple strategies for each account. Some are short term, some medium-term and others long term. Days like yesterday, illustrate the benefits of this multi-strategies. The money in the short-term strategies has been rapidly moved money. Some sales have taken place the day before the big drop. Others occurred shortly after trading began. If 25% of an account is quickly moved to cash in such cases, which reduces the overall risk of the portfolio substantially.
Thirdly, it is important that you be selective in what you sell. Liquidation of positions in the short term I can take high-dividend paying stocks and other investments that should comfortably storm. Even if the market is languishing, I want strategies that pay dividends of 6-9% ..
Posted on January 18, 2010.
