Seven Ways to Handle Market Stress

The current market environment is fraught with volatility , anxiety and uncertainty. It is during times like these that an individual investor is likely to make wrong decisions or avoid taking the proper action. (The same is true for any time of personal stress.)

I often get calls from clients, family and friends asking me how to deal with times of market stress, so this installment of the Finance Professor will discuss seven ways in which you can cope with markets during times of volatility.

1. Get Rid of Leverage

I have talked about leverage before. Leverage is a wonderful thing when the markets are going your way. However, during periods of increased volatility and declining markets, leverage can work against you (see margin call ). When leverage turns from friend to foe, it can erode your portfolio much faster than if you did not employ leverage at all. So if you have any margin balances, to cure the negative effects of leverage, I suggest that you pay those balances down as soon as you can.

2. Identify Risk and Reduce It

If you have been following this column, then by now you should have a spreadsheet of your holdings (see "The Finance Professor: Manage Risk Like a Pro"). If you don't have that spreadsheet, now is the perfect time to put it together.

Now, here is what needs to be done with your spreadsheet:

First, take your holdings spreadsheet and identify your risk to the market (for example, the S&P 500), by ascertaining each individual position's beta . How? For each individual stock holding, multiply the holding size in shares by the stock price and then multiply that amount by the stock's beta.

Let's say that you own 1,000 shares of McDonald's (MCD Quote), which is selling at $50 with a beta of 1.68. While you own $50,000 of McDonald's, your market beta or risk is $84,000 (1,000 multiplied by $50 multiplied by 1.68).