Five things you shouldn't do when stock markets fall

COURTESY - BUSINESS LINE

As you watched the Sensex zip past 20,000 in October, you told yourself – “I missed this one! But I'll wait for a correction”. Well, the wait is now over. The Sensex has dipped by over 10 per cent since New Year, with some stocks plunging by as much as 20-30 per cent.

What you, as a young investor, should do now is quite clear. You should be putting away some of your savings (in measured doses) into blue-chip stocks or equity mutual funds for the long term. However, that's easier said that done. So we thought we had better tell you what you shouldn't do in a market fall! Don't:

Head for the exit door

A few months ago, you carefully picked blue-chip stocks and decided to buy them for your retirement. Your ‘portfolio' was doing fine until the markets began to correct. Now, with many of those buys dipping below your purchase price, you wonder if you did the right thing. Should you sell the whole lot now, while the going is good?

Stop right there and think back to why you bought stocks in the first place. Was it because you hoped to double your money in six months? Or was it because you'll have a Rs 1 crore portfolio on retirement? If it was the latter, you should now be buying instead of selling.

Yes, the stocks you hold can sink further in the short term (next six months to a year), but selling them will leave you with no new avenues to meet your goals. Many investors who kept selling their stock and equity fund holdings in 2008 as the markets plunged all the way from 21,000 to 9,000, never had the nerve to re-invest that money at lower levels.

Switch to ‘safer' options

Most people seem to be quite comfortable with the risks of equity investing until they actually come face to face with them! Santhanam, an IT professional in his forties, wanted to build a portfolio of ‘high risk-high return' mutual funds, three months ago. We promptly suggested a few funds that invest in small-cap stocks. Today the portfolio sports a loss of 20 per cent. Santhanam says he wasn't prepared for this. Should he switch into safer fixed deposits which will give him 8 per cent a year?

Shifting money out of stocks or equity funds, after you have made losses on them is the worst thing you can do. By suffering a 20 per cent loss on his portfolio, Santhanam has already borne the brunt of equity risks. Why not stay put to reap its rewards?

In Santhanam's case the stock market has shaved 20 per cent off his wealth in just three months. However, if he switches the money into fixed deposits now, it is going to take him two and a half years just to recoup capital.

The only investment that can help you recoup losses suffered in equities is the equity market itself. So set aside a certain proportion of your savings towards equity investments (say 20 per cent) and don't lose your nerve if markets fall. When it does, buy stocks.

Scrounge for penny stocks

Okay, the market has fallen 10 per cent and most stocks are cheaper than they were just weeks ago. So what should you buy? For most of us, the first impulse is to scrounge for stocks trading at less than a magic figure of Rs 10.

After all, why should I buy 50 shares of ONGC at a stiff Rs 1,200 a share, when I can get 1,70,000 shares of the intriguing Cals Refineries, at 35 paise apiece for the same sum? Well, because ONGC has a running and thriving business in oil refining which makes it a much safer bet.

Blue-chips like ONGC may not multiply in a month, but they offer far greater certainty of long-term returns, than penny stocks like Cals Refineries. Therefore, while you can quite easily bet Rs 35,000 on ONGC if you have a Rs 2 lakh plus portfolio, you certainly shouldn't be investing that big a sum on a dark horse like Cals Refineries.

Wait for the bottom

If you are looking to invest after a market fall, don't wait for the market to ‘bottom' out. The ‘bottom' in any falling market phase is evident only in hindsight.

Sudhish, who started on his first job in January 2009 wanted to make a start on equity investing soon after receiving his first pay packet. The Sensex was hovering at 9,500 levels then. However, thoroughly psyched by predictions on television that the Sensex would head down to 8,000 or even 6,600 levels, he stayed away. Once the up move started, it became more and more difficult to take the plunge; he finally began investing at 14,000 Sensex!

If you are a long-term investor, don't make too fine a point of timing. When market commentators on television tell you that the Sensex has broken through a key ‘support' and is plunging towards the abyss, they are addressing traders who would like to make a quick buck over a day or a week. Not the retail investor who buys a stock for 5 or 10 years. Remember that market ‘forecasts' can change as quickly as the weather!

Try ‘shorting' stocks

Despite all the wise-sounding counsel on television, believe us, no one has a clue on where the markets are headed in the short term. That's why predictions about where the Sensex is headed over a trading day are so often wrong.

That's why you should never be tempted into ‘shorting' a falling market or stock. The problem with selling stocks that you don't own (short selling) is that the price has to fall immediately for you to make money on the trade.

When you buy a stock and it refuses to move up you can always hold on to it, in the hope that you will be proved right in a month or even a year's time. However, when you short-sell a stock, you don't have that luxury.

To square up the position; you will need to buy the stock at a higher price if need be. Shorting is a sure way to lose your shirt in a whimsical market.