Five More Ways to Handle Market Stress

4. Don't Let Hedge Fund Madness Distract You

Take a look at what happened to Ospraie Management. The Ospraie Fund, which had $2.8 billion at the beginning of August, lost a reported 26.7% of its value during that month in the wake of a "substantial sell-off" in energy, mining and resource equity stocks. There's no doubt in my mind that Ospraie was highly leveraged and controlled a far greater amount than $2.8 billion of equities. Now they are liquidating and closing the fund. Ospraie is not alone.

Hedge fund managers are closing their funds en masse because they will not earn their performance fees, which typically are 20% of a fund's profits. (Don't miss: "Hedge Funds and You: What Individual Investors Need to Know") In a few years, many of these managers will open up a new fund with a similar investment format, thus wiping out their performance deficit and starting from a zero performance benchmark.

A prime example is John Meriwether, who after blowing up Long-Term Capital in 1998 started JWM Partners in 1999. (The latter fund has lost a sizeable percentage of its assets this year.)

The collateral damage caused by this systemic liquidation in the hedge fund industry is tremendous. When in liquidation mode, the primary focus is on selling at any price, not what price. Valuation and performance go out the door.

So who suffers? In the short run, it is the value and growth investors who see their investments being whipsawed without rational explanation. When your stock falls 10% in one day, you have to ask yourself if it's really worth 10% less or whether a leveraged liquidation is taking place without concern for price.

Again, if your investment bias and mandate is value and/or growth, then follow the advice of those investment managers who focus on value and/or growth. Become less concerned about short-term movements and stick to your long-term investment approach, with the full knowledge that the markets and your investments will not rise each and every year.

5. Don't Be a Chicken Little

When times are good the commentary in the media and elsewhere is positive. When times are bad we get the mirror image of that commentary, namely that "the world as we know it is coming to an end." Listening to either type of extreme commentary will lead you to become too ebullient during bull markets and too demoralized during bear markets.

Bear Stearns is gone (JPM Quote) and for all intents and purposes, Fannie Mae (FNM Quote) and Freddie Mac (FRE Quote) are now bankrupt. Calls for a market crash and global depression are gaining popularity. But we will survive. If you don't think so, then research the lessons learned from the demise of Continental Illinois, Kidder Peabody, Drexel Burnham and Long-Term Capital.

Your Homework

Determine what your style of trading or investment is. When you grade your performance this year, do so against peers in your asset class.

Make some changes in valuation mistakes that you may have made and look for future opportunities.

Avoid changing your investment style unless you are committed to a permanent style change.

If your stocks experience large price movements, determine if the cause is something other than valuation. Ascertain whether "margin clerks" or long-term investors are in charge of the price.

Don't be scared by the calls of doom and gloom.