This stock market needs a correction Opinion: Be proactive, not reactive — and buckle up

SAN FRANCISCO (MarketWatch) — When the stock market becomes unmanageable – as it’s been lately — you have to manage expectations.

Easier said than done. With the S&P 500 SPX -0.95%   down 2% on Thursday , and the Nasdaq COMP -1.34%   down 3%, anxiety grows and perspective goes.

What now? Contain your emotions. This market is in transition, and transitions are rarely as smooth as we would like. You have to find ways to handle change more skillfully. Not more easily, because change is hard. But competently, composed, and with the conviction that if you can’t do this yourself, there are trustworthy financial professionals who can help.

There’s an old truism about investing that a stock doesn’t know you own it and doesn’t care whether you make money or not. Yet after the stunning 30% return the S&P 500 gave investors in 2013, it’s been easy to welcome stocks back into the fold. That market meltdown is so 2008; all is forgiven, please come home.

Instead, stocks have been unforgiving. Another old adage -- “Don’t confuse brilliance with a bull market”-- also applies now. Anyone can make money in a bull market. Investors prove themselves when they can outsmart the average bear.

That’s your job now. The slide in highflying biotechnology IBB -2.90%and other momentum stocks could trigger a real correction for the S&P 500 – that painful 10%-plus tumble which hasn’t been experienced since the summer of 2011.

So pay attention to investors who’ve seen it all before. Retired market technician Bob Farrell is always a good resource. His 10 “Market Rules to Remember” offers investors a reality check on stocks, bonds and their money.

For example, consider Farrell’s Rule No. 6: “Fear and greed are stronger than long-term resolve.”

What Farrell is saying is that investors can be their own worst enemy. The counter to fear and greed is self-control. Don’t believe it’s different this time. Don’t chase the hottest sectors and stocks. Keep enough cash on hand so you’re not dumping stocks at fire-sale prices when pessimism is high.

In this way, you can be ready to buy when others are selling and scoop up the bargains from your stock-market shopping list (Always have a shopping list.)

Remember, Mr. Market is mortal. “There are no new eras -- excesses are never permanent,” Farrell noted in another of his famous rules.

In other words, wait for your pitch. Diversify your portfolio’s risk to a level that is true and honest, and then the stock market’s stumbles can become opportunities.

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Markets Fear Vs Greed

Investors are driven by two emotions: fear and greed. Too much fear can sink stocks well below where they should be. When investors get greedy, they can bid up stock prices way too far.

So what emotion is driving the market now? CNNMoney's Fear & Greed index makes it clear.

We look at 7 indicators:

•Stock Price Momentum: The S&P 500 (SPX) versus its 125-day moving average

•Stock Price Strength: The number of stocks hitting 52-week highs and lows on the New York Stock Exchange

•Stock Price Breadth: The volume of shares trading in stocks on the rise versus those declining.

•Put and Call Options: The put/call ratio, which compares the trading volume of bullish call options relative to the trading volume of bearish put options

•Junk Bond Demand: The spread between yields on investment grade bonds and junk bonds

•Market Volatility: The VIX (VIX), which measures volatility

•Safe Haven Demand: The difference in returns for stocks versus Treasuries

For each indicator, we look at how far they've veered from their average relative to how far they normally veer. We look at each on a scale from 0 - 100. The higher the reading, the greedier investors are being, and 50 is neutral.

Then we put all the indicators together - equally weighted - for a final index reading.

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