May 27, 2010

The valley of fear

The amount of fear in the market lately has been tremendous. That's a significant signal. Analyst Don Hays says the market has reached this level of fear (as indicated by certain tracking indicators) only seven times in the past 24 years! And guess what? Each of those times "produced outstanding investment junctures over the next 6-30 months." In other words, the high level of fear signaled significant buying opportunities.

That may not be the case this time around. No one knows. Perhaps past precedents no longer apply. But that always seems to be the case when fear reaches these levels. It's why seasoned investors regard "It's different this time" as four very dangerous words.

There are two primary ways to invest successfully in the stock market over time. One is to be an extremely nimble trader — which is exceptionally difficult. The other is to be a long-term investor. That's not easy either, but for a different reason.

The reason making money as a long-term investor is tough is that it requires an investor to ignore times of fear such as we're going through right now. You have to stay the course when others panic. Moreover, taking a long-term approach suggests that you should lean into the wind and be a buyer at times like these. No easy task.

Which game are you playing? The short-term trading game? Or the long-term investing game? Like it or not, you can't straddle the line between the two. If the urge to do so is overwhelming, maybe your asset allocation is tilted toward a greater level of risk than your true risk tolerance is willing to permit.

Knowing what it takes to succeed as a long-term investor is what drives me to keep putting money in the market despite current fear and volatility. For all I know, this market may keep going down for awhile. But even in that scenario, I'm still comfortable — okay, that's not the right word — maybe committed? — to a course that says, "This is my long-term risk capital, and I'm going to keep it working in the market."

Sure, I'll occasionally be wrong following this approach. But if history is any guide, I'll be right more than wrong and come out ahead in the end.

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