My Mother used to comfort me when I was a small child when I was sad, by telling me that “this too will pass” knowing that the importance of the event that made me sad would diminish over time.
Eckert Tolle also discusses this idea when teaching us how to live in the moment in The Power of Now.
But I believe that the concept also has relevance to investing.
For example, markets never stay in bull or bear modes forever. Wherever we are at any one point time will pass, not always quickly, but eventually market conditions will change. The same is true of “hot markets” or “hot stocks” or “hot commodities.” Just because they are going up today does not mean that they won’t go down tomorrow. What goes up does go down.
But the opposite can be true — not always, but often enough. The stock that goes down can also go back up.
What does this have to do with our investments?
When a stock appears that it can do no wrong, that it is going up and up and up, this too will pass. Realizing or being conscious of this fact can keep us in the present, but mindful of the future. It’s important that we stay aware that change can happen… and happen quickly. In good markets and as well as in bad markets it’s important to stay aware and diligent at all times.
And you may want to have a safety net.
One safety net is a stop-loss order. By placing a stop-loss order on your stocks, you minimize the downside damage if the market drops quickly. How does this work? Let’s say a stock is selling for $100 and it suddenly falls to $90. If you’ve placed a stop-loss order on your stock, it will be sold automatically when it hits $90 — as long as someone is willing to buy it at that price. If nobody will buy the stock at $90, it will be sold for the highest price someone is willing to pay less than $90. That price could be $87 or it could be $40.
But what if the stock dipped below $90 and then jumped back up to $105 and yours stock was sold at $89. Oops – the stock is gone and so is the profit. What’s worse is if you decide you want to buy it back, it’s going to cost you more.
You can try to remedy this problem by placing a stop-limit on the stock. For example, when we place the stop-loss price at $90 on the stock, we can also put a range of what we’re willing to sell the stock for. Let’s say the limit is between $85 and $90. If the stock goes lower than $85, it won’t be sold. It will only be sold if someone buys it between $85 and $90.
While this is cool, doing this has its challenges. For example, if you had that same $90 stop-loss order on our pretend stock on October 13, 2008 — when the NYSE fell 11 percent (or over 930 points) — you probably would still own that stock, because there weren’t many buyers that day. If you had put another stop-loss on the stock the following Monday, this time at $60 — because that’s probably where the stock finished that fateful day — you might have fared better on October 28, 2008 when the NYSE fell another 11 percent (or almost 890 points).
These, of course, are extreme circumstances, but they serve well as examples.
But if you didn’t put a stop-loss on any of your stocks? Well, there’s some comfort to be had in this idea — the events of October 2008 have passed. Today, we have a booming stock market again. If you kept the shares you owned they have probably recouped their value.
But also remember, as good as this stock market is now, this too shall pass.