How to Take Advantage of the Stock Market's Volatility

Last Updated May 25, 2010 4:29 PM EDT

Another day, another Dow roller coaster. Stocks sank fast this morning, with the Dow Jones Industrial Average plunging 244 points in the first two minutes of trading, spooked by Euro troubles, Korean tensions, bank worries, bad bagels on Wall Street, whatever.

By the end of the day, however, the market had regained almost of its early losses, with the Dow finishing down just 23 points. That's volatility, and that's what's driving most individual investors crazier than Spain, Greece, and Bank of America combined.

It's hard to find your way through the worry and figure out what to do when share prices gyrate like this. But there are ways to make the market mayhem work for you. Here's how to use that volatility, and calm your emotions on wild days like today:

  • Don't worry, be happy. The further you are from retirement, the happier you should be with stock market declines, reminds my CBS MoneyWatch colleague Jill Schlesinger. Back in this February video on a day when the market was plunging, Jill said: "This is what you want. If you contribute to a retirement plan, you want the market to go down, you want to buy shares at lower prices."
  • Go old school with dollar cost averaging. If you're buying shares of mutual funds every other week with regular contributions from your paycheck, you're going to get more shares now than you did at the beginning of the month, when the Dow touched its high for the year. The more volatile the stock or fund you are buying, the better dollar cost averaging will work.
  • Sell for the tax advantages. You will never hit the exact top or bottom price of a particular security, except by extreme happenstance. But if you own shares of a stock or mutual fund that has been beaten down since you bought it, sell it and take the capital losses. (This advice doesn't apply if your holdings are all in tax-advantaged retirement accounts.) But remember that you can't re-buy the same security for a month, so if you really like it, stay with it. If you do sell, keep in mind you may not want to be in cash for that whole month, just in case the volatility gods (or trading programs) decide to reverse course. So...
  • Keep a shopping list. Do you have a handful of stocks or a mutual fund you'd like to get into? You should. Keep your list ready and you can choose a day like today to buy in. Again -- that's not saying you'll hit the rock bottom. But you'll get in cheaper than you would have yesterday.
  • Becalm yourself with a plan. Know what percentage of your portfolio you want in domestic stocks, big stocks, small stocks, foreign stocks, and bonds. That basic asset allocation plan shouldn't change very often. And you can use the market's volatility to rebalance if one category has gotten ahead of the others by buying more of the beaten down and selling shares of the runaways. But only around the edges. If you're rebalancing your portfolio once, twice, or four times a year to stick to that allocation plan, you should do just fine in the long term. And in the short term? Just breathe, and be glad you're not a broker.
Photo by Artemuestra on Flickr.
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