The Day Ahead: Amid market volatility, common sense returns

Following the Nasdaq's most volatile day, market psychosis is everywhere. Time for common sense to make a comeback

Following the Nasdaq's most volatile day, market psychosis is everywhere. Time for common sense to make a comeback.

First the background. As you've probably noticed this morning, all the talking heads are in overdrive, the New York tabloids are screaming "Scary!" in big font sizes and investors are shell-shocked as the Nasdaq had its biggest one-day plunge and biggest one-day rebound within three hours.

If you weren't around to watch all the trading on Tuesday, you were lucky. By the end of the trading session things were decidedly normal. The Nasdaq was off about 74 points to 4,148 and the Dow Jones industrial average was down 57 to 11,164. Around 1 p.m. EDT, the Nasdaq tanked 13.6 percent as panic selling and margin calls kicked in. From the bottom to the close, the Nasdaq gyrated more than 25 percent.

Yes folks, volatility is here to stay. Traders flipped out on Monday over a Microsoft antitrust ruling that surprised no one. The Microsoft worries were enough for a 7 percent Nasdaq slide. On Tuesday, the tech-heavy Nasdaq went bonkers. Who knows what will happen today?

Here are some common sense themes that are worth revisiting.

1. Cash is king ...

In your portfolio: Just think of the one-day gains you could've had yesterday if you had the cash on hand to buy on dips. Bellwether Cisco Systems hit an afternoon low of 64 Tuesday and closed at 73 1/8. Oracle bottomed at 65 5/64 and closed at 75 15/16. Sun Microsystems hit a low of 71 3/4 to 90.

For dot-coms: It's old news that dot-coms are running out of cash. You should look at companies that have cash and can generate it in bad times. That means you'll have to forgo companies that rely on stock to fund operations. Profits actually matter. You know companies like Applied Materials and Solectron will be around in five years. Can you say that about CDNow, eToys and other e-tailers?

2. Don't borrow money to buy stocks

Would you take a cash advance on your credit card to gamble in Las Vegas? Bad idea, huh? On Wall Street it happens every day. Online brokers such as E*Trade and Ameritrade were issuing margin calls big time on Tuesday.

Many investors, especially the Internet variety, are borrowing money, known as buying on margin, to invest in stocks. Typically, an investor can borrow up to half the value of their stocks. Once the purchase is complete, the value of the stock minus the amount of the loan must equal at least 25 percent of the market value of the shares.

When stocks tank, margin calls happen. That means investors have to put up extra cash or sell shares to meet the broker requirements. Margin calls were a big reason behind Tuesday's volatility.

3. Diversify

You may have realised that your portfolio is a bit tech heavy. That strategy makes a lot of sense when stocks are racing along. However, stocks do tank.

A mix of old economy and new economy stocks would have cushioned the blow. Of course, we'd like to forget this old economy, new economy debate. It should really be a debate about investing in profitable companies vs. the merits of buying into companies that gush red ink and have no business being public in the first place.

4. Keep talking heads in perspective

If you compile all the comments from talking heads, pundits and Wall Street analysts, you have one incoherent investing strategy.

The good news is that Wall Street analysts will ease off the cheerleading to cover their backsides. The bad news is that the number of hedges in research notes will make investors even more confused.

Henry Blodget, an analyst for Merrill Lynch, has been warning about volatility a lot in recent research notes.

"We continue to recommend that aggressive investors with strong stomachs (the volatility isn't going away) place a small percentage of their overall portfolio (5 percent to 10 percent) in the leading Internet stocks," wrote Blodget in a recent note. "Given the sector's volatility, we would try to buy on major weakness and trim on frothy strength (easier said than done, obviously)."

In other words, time the market and pray.

Blodget's advice is to go with the leaders such as America Online, Yahoo, Amazon.com, eBay, Priceline.com, CMGI, Inktomi, ICG, Ariba and DoubleClick among others.

Merrill Lynch, however, has underwriting ties to most of those companies.

5. Go out and play

Watching your stocks all day long is unhealthy. Not only does excessive stock watching increase the chances you'll screw up your long-term strategy, it can give you market psychosis.

Mark Specker, an analyst at Wit SoundView, has the right attitude. "Stocks go up. Stocks go down," he said.

Now that spring is here, it may be a good idea to give CNBC a break. The sky isn't falling. Go check it out for yourself.

What do you think? Tell the Mailroom. And read what others have said.

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