Golden rules for a declining market

Paper losses are real only when you sell up.

While the craze for Internet and telecom shares continues unabated, it may have escaped most people's notice that the UK stock market has fallen nearly 10 per cent overall this year. The FTSE 100 benchmark index of 100 biggest companies has fallen from 6,930 at the beginning of the year to around 6,400 this week.

While the craze for Internet and telecom shares continues unabated, it may have escaped most people's notice that the UK stock market has fallen nearly 10 per cent overall this year. The FTSE 100 benchmark index of 100 biggest companies has fallen from 6,930 at the beginning of the year to around 6,400 this week.

So how should the private investor react to a declining market? "The value of shares can go down as well as up" is the standard warning. But when the market starts to tumble, the gut reaction of many private investors is to sell quickly in a falling market to avoid further losses. But this is more often the worst thing that you can do.

Historically, falls in share prices, even significant falls caused by stock market crashes, even out over time. For example, in two years the FTSE All Share Index was back to the level it was before the crash of October 1987 and more than doubled its pre-crash value within 10 years.

Good and well-researched investment decisions should withstand a bear market (a falling market) as well as a bull market (a rising one).

Losses on paper do not become real until you sell your shares, so it is best not to sell when markets are low unless you have to. Panic selling has a cumulative effect and can quicken the fall in a market.

But private investors can protect themselves in a falling market. Here are golden rules for survival:

Don't panic: or sell in haste - you may regret it later.

Take a long-term view: because five years is a sensible minimum. Markets always recover, given enough time.

Ensure your portfolio is balanced: with shares in different sectors of the market. Ensure blue chip companies form the basis of your portfolio. These are large well-established companies, often high street names, which keep their value over the long term.

Adopt a drip-feed approach to investment: by putting a little money in the stock market at regular intervals. This means you will be buying shares at different times and at different prices but you will pay a price somewhere in the middle. Avoid investing a lump sum at the top of the market. Investing in unit and investment trust saving schemes and participating in investment clubs are ways to adopt this approach.

Follow the professionals: who view a falling or low market as a buying opportunity - to purchase what are fundamentally good investments at a bargain price.

If you have to get out of a falling market: you should not have been in that position, ideally. You should invest only money you can afford to forget about, so you can sell your investments when you want, not being forced to sell when share prices are low.

But emergencies occur and you may have to sell shares when you are not able to gain maximum profits. In this instance, take comfort in the fact that if you invested in the shares more than a couple of years ago, you will probably have increased the value of your investment by more than if you left the money in the building society.

Stop-loss policies: are set up usually by more active investors to preserve the value of their portfolios. These are a controlled and planned way to sell investments and might work as follows:

If you have bought shares for 100 pence (£1), you might decide that you wish to set a stop-loss of 20 per cent. You would automatically sell your shares if the share price fell below 80p - ie by more than 20 per cent of the purchase price.

A stop-loss can either be set on the purchase price of the share or adjusted as the share price moves up. In other words, if the shares move up to 200p you would sell at 160p (200p less 20 per cent). This is known as a rolling stop-loss.

Stop-loss limits should not be adjusted as share prices fall or they will be ineffective. But the best advice for most investors in a volatile market is still to hold for the longer term.

For further information contact ProShare, the organisation which campaigns for wider share ownership, on 0171 394 5200 or www.proshare.org.uk