Everyone knows how difficult it is to do the opposite of what the crowd is doing, especially during manias and panics. But that's precisely what you must do if you want your best shot at beating other traders, and beating the market.
Five simple rules
Simple isn't the same as easy, so follow these few rules to help make market panics work for us -- and to help make our process nimbler in these days of quick market reversals.
1. Plan Foolishly.
Your portfolio should reflect your individual financial realities. Are you living off your investments? Then you may not want to be in stocks at all. Got 30 years until retirement? Bonds are probably a bad bet.
2. Reassess your risk tolerance.
If you can't sleep at night following 10%, 20%, or even 40% downswings in individual stocks, then you shouldn't be buying them at all.
3. Plan ahead.
The middle of a market panic is no time to change your asset allocations. Taking a big bath on stocks in order to move the funds into "safer" assets locks in losses.
4. Keep a cash cushion.
I've long advised people to keep at least six months' worth of living expenses in cash in case the worst happens. In addition, stock investors should keep enough investing cash on hand to buy three or four positions so that they're ready to take advantage of market sell-offs.
5. Keep a shopping list.
Know what stocks you'd like to own and the prices you'd like to pay. Computer-driven drops can reverse in minutes. Your shopping list helps you move quickly enough to take advantage of the market's irrational fits.
Extract from Investing