Here’s How Smart Investors Think About Stock Market Sell-Offs

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The Dow Jones Industrial Average plunged more than 800 points on Wednesday, a drop of 3.1% and the worst one-day plunge since February. The Nasdaq fared even worse, as tech stocks led the downward momentum. This extends a multiday slump that has caused many popular stocks to lose significant value.

While nobody likes to watch their portfolio's value drop, when the market moves like this, it's a good time to take a step back and consider what a stock market sell-off really is: an opportunity to pick up stocks you've been watching while they're on sale.

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The right way to think about a stock market sell-off

If your favorite store decided to mark down everything it was selling by 10%, what would you call that? You'd call it a sale, right?

I mentioned that tech stocks have been some of the hardest-hit in this market drop. This isn't too surprising, as these stocks have done remarkably well as a group in recent years. So, let's say that you had been thinking about investing in some exciting tech companies but had been hesitant because of their high share prices. Well, look at what has happened over the past several days to the FANG stocks:

To be clear, when I say that stock market drops create buying opportunities, I'm only talking about high-quality companies whose business you believe in for the long term. Different investors have had different, colorful ways of phrasing this concept over the years, but just remember that marked-down junk is still junk.

Couldn't the stock market go down even further?

Absolutely. The Dow could fall another 600 points tomorrow, or it could increase by the same amount just as easily. There's no way to know for sure. Trying to time the market is a losing battle.

Consider one of my favorite stocks in the market, Square (NYSE: SQ), which hit an all-time high of more than $100 just a couple of weeks ago. After the recent market drop, Square is trading for about $78 as I write this, so I might consider buying more soon. (Note: I can't buy any stocks I mention for a few days.)

However, let's say that the market drops even more, and that Square goes all the way down to $60. Would I regret having bought more at $78? Absolutely not -- I'd probably buy even more because I think it'll be worth much more 5, 10, or 20 years from now.

My point is that you shouldn't try to time the market. A stock whose business you like and that's now trading for less than it was is on sale. Just because the sale could possibly get even better isn't a reason to ignore the fact that it's on sale now.

Don't fall victim to your emotions

Stock market drops like these can be scary. As I mentioned, nobody likes to see the value of their portfolio go down. My personal portfolio beat the overall market on Wednesday (I own few tech stocks and lots of defensive names like REITs), and its value still dropped by thousands of dollars.

Our instinct when we see our account value in free fall is to sell before it goes down any further. However, this is the absolute worst thing you can do when the market plunges. There are some good reasons to sell stocks, but this is certainly not one of them. In fact, it's well documented that the average investor significantly underperforms the market, and one major reason is that they do the opposite of what they should: selling when stocks drop and buying after they've gone up.

Think of it this way: If you were shopping on Amazon.com and everything on its site was suddenly marked down by 20%, would you panic and turn off your computer? Of course not. So, why would you effectively do the same thing when Amazon's (or any other) stock goes on sale.

The bottom line is that while a stock market drop can be frightening, especially if it lasts for several days, it's times like these when you should take a step back and think about buying stocks that you've had your eye on.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Matthew Frankel, CFP owns shares of Square and has the following options: short December 2018 $90 calls on Square. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Facebook, Netflix, and Square. The Motley Fool has the following options: short January 2019 $80 calls on Square. The Motley Fool has a disclosure policy.