Anyone who has invested for more than a few years has seen screens turn deep red, headlines grow alarming, and portfolios shrink within days. These moments test even the most prepared participants. Those relying on intraday stocks for today may find their positions stopped out in rapid succession, while holders of long term stock picks must resist the urge to abandon sound businesses at depressed prices. Volatility is a permanent feature of equity markets, and learning to respond to it calmly is among the most valuable skills an investor can develop.
Why Markets Fall and Rise So Sharply
Stock prices are determined by people’s expectations about future earnings, interest rates, liquidity and risk going forward, so when new information comes to light, stock prices can sometimes move quite violently. This could be due to a change in interest rate policy, unexpected inflation, foreign institutional selling, geopolitical issues, poor earnings or regulatory news.
In addition, sentiment can cause volatility. If there is an increase in fear then people will start selling and liquidity will dry up, causing stock prices to correct. Conversely, if there is an increase in euphoria, then stocks can get overvalued. However, knowing that markets tend to go from very bullish to bearish will help you avoid getting caught up in the emotion.
Corrections Are Common
The Indian equity indices have seen many corrections of 10% and more. Some corrections have been 20% and more. They haven’t always been quick to recover; however, historically the market has always gone on to new highs as company earnings have increased. This isn’t guaranteed but shows that corrections have been common throughout the journey.
Knowing this means you’re not going to be hit with a surprise. You will know that corrections happen regularly.
Prepare For The Storm
When the market is stable is the best time to prepare. Have some spare cash so that when the market goes against you, you will never have to sell equities to cover costs. Have a chunk of your portfolio invested in assets that won’t be as volatile; depending on your risk profile this could be debt funds, fixed deposits, gold etc. Don’t get into any leverage as a correction could turn into a real loss.
Having a good asset allocation will also protect you. If you have a well balanced portfolio you won’t feel the pain as much as someone who has all their money in small cap equities.
When The Market Falls…
Take a step back. Try not to make any big decisions in the first few hours of a sharp fall. See what your plan is and whether anything has changed in the fundamentals of your stocks. A fall in price due to overall fear in the market is different to a fall in price due to a decline in business.
Check your cash and commitments. If you have extra cash and are confident then you could top up gradually. No one knows where the bottom is so topping up gradually could work. Keep investing systematically to get more units in at a cheaper price.
Reduce the noise. Try to limit how much you’re hearing about how bad things are. Stick to company announcements and trustworthy sources.
Trading Tips
Short term investors can get into trouble during volatile periods. You will see a bigger range in prices which can cause you to hit your stop loss multiple times. Gaps can also cause you to lose more than intended. Reduce your position size, number of assets you’re investing in and increase your stop loss range but reduce the amount you’re investing to keep the same level of rupee risk.
Don’t try to make up your losses by increasing your bets. This is often referred to as revenge trading and is one of the most certain ways to increase your drawdown. If you are making mistakes then taking a few days out is completely legitimate and a very professional move.
Look For Opportunities
Often when the market is fearful there are opportunities to buy quality businesses at cheaper prices. However it can be uncomfortable as the news is negative and the future is unknown. Those who have prepared ahead of time by having a watchlist and target price will feel more confident.
However it’s common to be early and the price could continue to fall. It’s important to invest gradually.
Review Your Actions
Once the market has settled down have a think about how you reacted. Did you follow your plan? Was your asset allocation correct? Did any of your stocks let you down due to fundamentals? This will help improve your strategy for next time.
You cannot avoid volatility however you can avoid panicking. If you have a solid plan, realistic expectations and good habits in place you will be able to ride through corrections without losing any of your capital.
