What to do in a spooked market

Monday, September 23, 2013

What to do in a spooked market

 An investor's guide

Investing in the stock market can be scary in itself, and surviving a spooked market can be downright terrifying. The unfortunate news is that markets (especially after 2008) have become more vulnerable to developments – like financial changes at home and abroad, economic performance data, currency performance and political factors – and there appears little chance of markets becoming bullish enough to shrug off such happenings.

Image credit: lightwise / 123RF Stock Photo

Generally, a spooked market witnesses one or more of the following:

  • Rapid selling by foreign (and domestic) players, which pushes the currency – and stocks – down.
  • Panicking investors seek better options like gold, etc; they end up selling a majority of the stocks at a loss.
  • The rapid selling of stocks pushes the stock market further down.

From the above, we note that apart from the original factor (which can be economic or political), a large part is played by sentiment, causing stocks to fall further than the companies' health warrants. It is true that some of the stocks may be over-valued (as happened in 2000), but in nine out of ten cases even healthy and high-yielding stocks experience a severe beating. In such circumstances, what should one do to ensure that not only does one not make a loss, but actually creates future profit possibilities?

  1. Firstly, be psychologically prepared – One of the best ways of surviving a spooked market is to be mentally prepared to experience losses. Further, one should factor in the amount of loss one is ready to suffer. Decide accordingly if you want to invest in profitable yet high-risk stocks or stay defensive.
  2. Don't go with market sentiment – Sometimes doing what everyone is doing isn't right. Always remember that equity is your best choice, no matter what. Hence, selling equity in a hurry can cause permanent damage to your finances. Ideally, you should have a Systematic Investment Plan (SIP) and you should stick to it, even during a market crash.
  3. Diversify your portfolio – A sure-shot process of surviving in a falling market is to diversify your portfolio. Choose good companies across a variety of fields. The question arises, how to determine whether a company is trustworthy or not? Here's how :

·         Check the beta of stock – The most profitable stocks may not be stable, i.e. They may rise and fall faster than the stock market itself. The rise or fall of a stock in comparison to the stock market in general is called the beta of the stock. Say a stock falls or rises 1.88 times the general market trend. This is a high risk stock since a decrease of 1.88 times the normal fall of a falling market will grow up your losses. If you want to play defensive, choose stocks with a beta of 1.0 or less.

·         See fundamentals of the company – Good stocks are those which pay a regular dividend at a rising rate over the years. When deciding, you should also keep in mind the financial health of the company, its ability to generate enough profits and whether it has raised its rates regularly over the years. If these are good, chances are that such stocks will improve when market correction occurs. Then you can either hold onto the stocks and enjoy the dividends or sell them at a profit.

·         Compare fall in comparison to its peers - Check the degree by which the stock has fallen in comparison to its peers. The stock that fall less (even though absolute fall may be more) is a comparatively safe stock to invest in.

Finally, always remember that surviving and profiting in a spooked market takes careful and calm analysis. To summarize the above - a decent long-term investment strategy, thorough analysis of companies and a calm mind - can let you survive any spooked market.

Author: Aritra Majumdar

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