When cooking in the kitchen we may remind ourselves not to catch a falling knife. We recognize it will cut us if we catch it on the way down. It is better to let it fall, getting hands and feet out of the way… and then pick it up.

However, sometimes it is easier said then done. Reflex kicks in when the knife drops and we reach for it. To avoid grabbing the knife as it falls typically requires planning ahead of time not to catch it and then discipline to avoid reaching for it. It is easy to make a mistake when reacting to a situation without upfront planning.

The same is true for many investments… in particular the stock markets when we see dramatic declines in a market. Sometimes the temptation is to jump in quickly to a market that is seeing dramatic declines. However, this can be a lot like trying to catch a falling knife. Sometimes the market will rebound and sometimes it continues to fall. You may want to wait to make sure it has finished falling before you get substantially in. You certainly don’t want to make that decision on a reflex or without a plan.  A market decline is one of the times that a clear, well thought out plan really helps.

For effective long term “investors”, or the “investment” section of our portfolios, a sharp decline can be a good opportunity to buy some stocks you have already researched and targeted.  An effective long term investor already had a plan for a market decline. They had cash or liquid fixed income on the sidelines they could use to buy stocks when the price falls. They have an idea of what they want to buy and for what time horizon. They have already considered a strategy to cost average in or rebalance their portfolios as the markets decline. They are less “reactive” and minimize risk of “panic” decisions because they had a clear plan.

If you are a long term investor and did not prepare for a decline… maybe your plan was just to ride out the short term storms, holding the same assets you held on the way in. While this is a long term strategy and it minimizes the chance for panic selling at a market bottom, you may want to look for a chance to rebalance your portfolio.  Are there some investments you think have a better chance of recovering quickly than the ones you are currently holding?  Do not rush into changing your strategy. Consider carefully. You may want to seek competent professional advice.

If you are a non professional “trader” or have part of your portfolio reserved for trading you want to consider a few key points.

• You should already have a plan for this scenario. If you had a good plan you should stick to it… or at least revisit it before you start making quick decisions to buy or sell stocks on emotion or reflex.
• If you didn’t… you are now reacting with emotion and reflex. Take some time to ensure you are calm and evaluate a strategy from where you are at the moment.
• Avoid the psychology of holding onto a losing position… hoping it to become a winning position if you can hold out long enough.  Try to make decisions based on the facts rather than emotion.
• If the basic reasoning, or thesis, for your trades is no longer valid you need to be willing to change your positions (take a loss if necessary) and position for recovery.
• Avoid the assumption that you “must be near the bottom” and thus can put everything into the market. Be prepared for the market to stabilize, recover, or continue declining. Avoid “betting” on one direction.

If you are a non-professional trader and have a large portion (or all) of your portfolio dedicated to “trading” instead of a more stable approach with some dedicated to longer term “investing”… now may be a good time to reconsider. You may look at “trading” into some high quality names, perhaps with dividend, diversified across sectors and convert some of your portfolio to “investment” as diversification to your “trading” portfolio.

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