Friday, August 21, 2009

Strong Weak Hands

Did the recent market meltdown send you running to sell your stocks at the first sign of panic? While it's not a recommendation I would make, a recent study argues that it's also not the worst thing in the world. A paper called “When Everyone Runs for the Exit,” by a professor of finance at New York University, looked at the way investors react to serious market downturns, and the results are pretty interesting.

Buy-and-hold still works in these situation, but only if you've got the fortitude to wait out the crisis. Even better if you've got the wherewithal to buy cheap assets in the midst of the downturn. If not, the best move appears to be selling at the first sign of crisis. The phrase "cut your losses" would apply here.

The people who really get killed during market downturns are what the paper calls the “strongest weak hands.” They hold on for a while, hoping the markets will recover, then sell off in the midst of the crisis, when prices tend to be low.

These findings are all intuitive when you take a step back and think about them. The problem is, when a financial crisis hits, most people don't take that step back. "If you can keep your head when all about you are losing theirs," Rudyard Kipling wrote, "then you'll be a man." And, he might have added, a wealthier man.

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