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Nerves of Steel

By Charles Hopkins Published 11/27/2007 | Finance
Investing in todays financial markets takes at least a bit of control over your emotions. Some say it takes nerves of steel. It is certainly true that last months market turmoil has rattled investors. Consider many of the big boys having to write off billions due to bad loans. What does that mean for the smaller private investors?

Of course to a very large extent it depends on what type of investor you are. Are you a traditional Buy and Hold type of person? In that case the current market slide probably won't stir you that much. You may view it as a nice moment to get some bargains and add some friendly priced stocks or mutual funds to your portfolio. The only slightly difficult thing here is that seemingly hard to grasp phenomenon known as market timing. Who knows what a good price is? Is it good today just because it was higher yesterday? If so, will you still consider it good tomorrow if tomorrows price turns out to be even lower? Of course fundamental analysis can give you some guidance on what a good price could be, but these days P/E ratio's don't always carry the same meaning as they used to.

Of course to someone who is more of a trader the last few weeks have probably been pretty exciting. Whether or not that is positive or not depends on the way that they have managed their risk. What is an exciting, but perhaps bumpy, ride for one could be a nerve-wrecking slide for someone else. For many private investors risk management is easier said than done. If you lack the discipline to put risk management in place and act on it when called for it easily lead to an unpleasant situation. A serious drop in market value could have an immediate effect on the buying power of your portfolio. And if you've used margin, for instance by shorting uncovered stocks, that leverage could quickly start working against you. In that case you'll probably need a bit more that just a little control over your emotions.

Nerves of steel could help you sleep better in a situation like this but when push comes to shove it won't pick up the check. It is good to the extent where it keeps you from becoming too jumpy and making decisions driven by fear. It can be very bad when it makes you become cocky, thinking your cool will save you when markets continue to fall. It won't. Nor will it stop a margin call from your brokerage firm. It's great if you don't panic when the markets don't do exactly what you, or everyone else, expected. Much money can be made if you can keep your act together in a situation like that. But it's even greater if you've got your risk management in place so that your nerves aren't put to the test when things take an unexpected turn.