institutional selling

At Legg Mason (NYSE: LM), for instance, there was $18.4 billion in net redemptions in the quarter ending in June. Amazingly, that was an improvement from the $19.2 billion in the previous one. The fund run by Bill Miller, whose legendary 15-year streak of beating the market was unparalleled in recent times, represented around $2.4 billion worth of Legg Mason's first-half redemptions.

As investors' money leaves an institution's control, fund managers can be forced to sell stock to meet those redemptions. When billions of dollars flow out of a fund, its manager is left with no choice but to sell some of the stocks it holds to come up with the cash. Since many of these funds share the same holdings, all of that forced selling drives their prices down.

In a perfect world, a fund manager would be able to pick which shares to sell based on valuation. The more expensive a stock relative to its true worth, the more of it the fund manager would sell, thereby minimizing the long-term damage to the fund. In the real world, however, a fund manager facing huge redemptions will sell whatever stocks happen to be liquid enough to support it.

There aren't all that many stocks with enough trading volume to support a sell-off of that magnitude. Over the past month, for instance, there have only been 69 individual company stocks across the U.S. and Canada with at least half a billion dollars' worth of average daily trade volume. They're virtually all names you know.

If a single fund manager needs to sell tens of millions of dollars in a single day just to meet redemptions, these highly liquid stocks are about the only ones that manager can easily sell. Multiply that impact by all the fund managers who face redemptions in a generally declining market, and you can see how stock prices can quickly plummet.

... As an individual investor managing your own money, you're not beholden to the redemption pressure that massive mutual funds feel. On the contrary, you can do what those fund managers only dream of doing: buy into an irrational, forced sell-off.