Sell, buy, sit tight: There are good reasons to do all three.

Its been an up-and-down two months for stock markets, and there could be more trouble ahead. So what should you do when the market drops? There are three possible responses.

Sell: Whenever markets start to slide, some investors flee. At least, thats the way the media and some analysts portray their behaviour. Panic selling is the term often used.

Sometimes that is what happens nervous investors dump quality stocks because they want out of the market at any cost. But thats not always the case. There can be sound strategic reasons for calling your broker.

For instance, theres the possibility that things will get worse before they get better. Think back to the fall of 2008. World stock markets went into freefall on Sept. 15 after the collapse of investment banker Lehman Brothers, with the Dow Jones Industrial Average plunging 499 points.

People who sold into that slide may have appeared to be panicking. But there was worse, much worse, to come. During the week of Oct. 8, the Dow dropped another 18 per cent while the S&P 500 lost more than 20 per cent. Things were no better here in Canada.

Some market watchers thought that might be the bottom or close to it. It wasnt. The carnage continued through the rest of 2008 and most of the winter of 2009, finally petering out on March 9. Those who sold back on Sept. 15 looked like strategic geniuses.

Another reason to sell into a falling market is to lock in gains. Stocks had been on a steady climb for three years prior to the correction that began this September. In fact, the Dow, the S&P and the TSX all posted record highs over the summer. Even with the pullback, many investors were sitting on fat gains. They cant be blamed for wanting to take that cash off the table.

Buy: As stocks moved into official correction territory earlier this month, some money managers said they were starting to buy. Why not? Quality companies in the energy sector were being offered 20 per cent or more below their prices of only a few weeks earlier. The pros know bargains when they see them.

But they could go lower, right? Sure. But the major producers arent going out of business. The world will continue to need oil and gas. The drop in oil prices may knock out some smaller companies and postpone projects, but its not going to destroy the industry. Why wouldnt a smart investor buy Suncor Energy at 20 per cent off its 52-week high and collect a nice three per cent dividend while waiting for it to recover?

Stand pat: Scoffers may call this inertia or even paralysis, but theres a good argument for doing nothing when markets tumble.

For starters, even though crashes are frightening, we know that the long-term trend of the markets is up. Sometimes it takes a few years to recover from particularly traumatic events like the plunge of 2008-09, but those who held on to quality securities during that traumatic time were better than those who sold everything and failed to get back in for the rally that began in the spring of 2009.

Then there are the costs of bailing out. Even if you use a discount broker, there is a commission paid on every stock sale. The capital gains tax liability incurred when you sell at a profit outside a registered plan can be even more expensive. Yes, the value of your portfolio will temporarily drop if you sit tight. But it will eventually recover. The money paid in commissions and taxes is gone for good.

No single approach is right for everyone in a market correction. Carefully consider your own circumstances and then decide on the right course of action both for your wealth and your peace of mind.

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