10 Lessons Learned in the Selloff

6) A Major Shift Is a Subtle Process

For the past two years, investors have managed to ignore a lot of negatives: rising prices, removal of Fed accommodation, increasing energy costs, geopolitical turmoil. These have made up the so-called "Wall of Worry."

At a certain point, however, mere hand-wringing from the permabear crowd shifts into issues that should be of genuine concern to markets. That process is a subtle one -- and it should not be ignored.

John Maynard Keynes compared the stock markets to "a newspaper beauty contest in which the prize goes to the reader whose choice most resembles the average pick." The goal isn't to pick who you believe is the prettiest, but rather, who you believe everyone else will pick as the prettiest.

When it comes to sentiment, your own beliefs matter little. It's the crowd's psychology that is all important. I hear too many of us lament that the crowd is wrong. Pay attention to the shift from the "Wall of Worry" to the "What? Me Worry?" That's where the subtle transition from complacency to risk-aversion takes place -- and leads to broader selloffs in the future.

7) Stop Losses Are Lifesavers

Suffice it to say that if you are going to bottom-fish in dangerous waters, you need protection. I made numerous buy attempts in the past two weeks and got stopped out of them all -- considerably higher than where we are today. It didn't even sting. Without the stops, I would be extremely unhappy -- and considerably poorer.

(I've addressed this issue extensively before here and here.)

8) Money Management Is Crucial

One of the things we don't discuss often enough is position sizing: How large should any given trade be relative to your overall portfolio? The answer depends on what you are doing at that moment.

If you are building a position in a favorite stock over time -- say 5%-7% of your portfolio -- it makes sense to slowly add size. Use volatility to buy on short downswings. Scale in slowly.