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What Investors Should Do On Negative News

As we approach the midpoint of 2010, there are plenty of headlines to fret about. Among them: a fragile economic recovery, the metastasizing debt crisis in Europe and weakness of the euro, China’s slowdown (even if it is intentional), the oil leak in the Gulf, the “flash crash,” reform that will change the financial industry, and more.

The result is a lot of nervousness, and in that environment it’s human nature to sell quicker and react more to short-term developments than under more normal conditions. We’ve seen that in the heightened volatility and higher trading volumes recently.

But you have to be careful. Those kinds of decisions may end up being right, but they can backfire on you, too.

It’s most important in times like this to reassess your investments before making a snap decision to unload. Analyze whether the reasons you bought the stock initially are still in place. If they are, you may want to look past the short-term turbulence in anticipation of a longer-term payoff (unless there are other considerations such as needing the cash).

If the fundamental argument for owning the stock has changed, there is really no reason to hang on. There is no shame in selling, but letting go seems to be much harder for investors than buying. That’s because selling, especially at a loss, means admitting a mistake. But don’t forget: you can always buy in again later — presumably at lower prices — if the story becomes attractive again.

Just be sure to consult a tax professional before you do as there are things to consider, like the IRS “wash sale” rule that prevents you from deducting a loss if you re-buy a stock you’ve sold less than 30 days prior.

We had an example of this approach in my Wall Street newsletter when John Calamos, one of our regular contributors, recommended selling Transocean (RIG) on May 7. Transocean owns the drilling rig involved in the oil spill (BP operates it). John recommended selling not only because of lost revenue to the company, which has become a significantly bigger problem now that the situation has worsened, but for a bigger-picture reason as well.

“The longer-term question is whether politicians will curtail offshore drilling in the Gulf of Mexico,” he told us. “With approximately 20% of its fleet in that area, a significant percentage of RIG's revenue and operating profit is at risk. It has more active rigs in the Gulf than any other contractor.”

So like the pros, take time to reassess before you pull the trigger and sell. In a volatile market, many good stocks fall along with the bad as investors react to headlines. You may decide a stock should be sold, but you’ll feel better making that decision yourself and on your own terms rather than simply following the crowd.

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