Stock market corrections can be brutal. At its depths of 2023, the Nasdaq composite was down more than 32% while highflying growth stocks suffered even worse drawdowns.
X
This is why it is key that investors have a proven plan in place on how they are going to manage their stock portfolios during corrections. Following a buy-and-hold strategy can wipe out years of gains in a short space of time.
There is also the key caveat that the beloved stock market leader that is the pride of your portfolio may end up become a millstone weighing down your returns.
“Most stocks fall during a bear market, but not all of them recover,” IBD founder William J. O’Neil wrote in “How to Make Money in Stocks.” “If you hold on during even a modest bear market correction you can get stuck with damaged merchandise that may never see its former highs.”
A good example of this is the performance of Cisco Systems (CSCO). The computer networking stock hit an all-time high of 82 in March 2000. While it has recovered from its subsequent October 2002 low of 8.12 it has yet to come close to hitting its old high watermark, even 22 years later.
What To Do During A Stock Market Correction
First of all, avoid buying stocks during a downtrend. This will help prevent you getting sucked into a bear market trap. Reversals can be particularly severe at this time.
It is also risky to hold on to a stock during a stock market correction. This is because drawdowns on major indexes pull the majority of stocks down with it.
To make money over the long-term, protecting profits is crucial. Consider selling your weaker holdings, especially if you are holding a small loss or are at break-even.
You should always sell if a stock drops 7% below what you paid for it. But selling sooner can pay off when the market is weak as a capital-preservation strategy. The 50-day moving average is a key benchmark. If a stock falls sharply below this level in heavy volume, it is another important sell signal.
You should also be keeping a watchful eye on your strongest holdings. Locking in profits is important if signs of trouble emerge. Investors should not be afraid to take profits because there will always be opportunities to buy back market leaders.
A key point often overlooked even by experienced investors is setting a target sell price for any stock still owned. This is crucial if one is to avoid allowing healthy gains to turn into painful losses. A defensive sell price takes some of the emotion out of the equation — a key to preserving mental capital.
For example, if you have gained 20% in a stock you could opt to sell if the gain drops to 10%. Having a set line in the sand will protect investors from dithering at the worst possible moment.
Don’t Forget This Key Point For Future Gains
It is all to easy to switch off and become disengaged from the market when a correction is underway. This is a dangerous mistake because a market bottom can catch you unprepared.
One should be keeping a close eye on the market and building a robust watchlist of top stocks. Look for names that are showing unusual relative strength. The fact a stock is holding up while the broader market is falling is often a good indicator that it is ready to show leadership when an uptrend inevitably resumes.
This article was originally published Aug. 12, 2022, and has been updated. Please follow Michael Larkin on Twitter at @IBD_MLarkin for more analysis of growth stocks.
YOU MIGHT ALSO LIKE:
Stock Market Rallies Amid Presidential Election Drama
These Are The 5 Best Stocks To Buy And Watch Now
This Is The Ultimate Warren Buffett Stock, But Should You Buy It?
Signup bonus from
