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The stock market has seen a sharp correction over the few days, making investors anxious and jittery. It is often during a sliding market when investors make ill-advised moves. And end up paying a heavy price. Here are a few common mistakes that investors should avoid in this situation.
1. Getting anchored to a price
INVESTORS OFTEN set a benchmark price for the shares they hold. This benchmark is usually the purchase price but could also be the highest level touched by the stock. Future decisions on the stock are based on this price. In a falling market, anchoring to a price level can make investors hold on to stocks longer than they should.
The share price may have dropped due to any reason but investors hold on because it is below the value to which they have anchored the investment. They cling on to hope that the price will revert to that level without assessing the fundamentals of the stock.
If the price has dropped, find out the reasons for the decline. If there are justifiable reasons for the drop—such as lack of earnings visibility, deteriorating balance sheet, corporate governance issues— it is better to cut your losses and exit. Alok Churiwala, MD, Churiwala Securities, says, “Investors must realise that the price at which they bought the stock is not what the market has discerned as its fair value.”
2. Buying more to average
EVERY BODY makes mistakes, but some investors tend to compound them. If the stock you purchased drops, don’t try to buy more shares to bring down your average buying price. Investors often try to cover their losses by buying more of the same shares at the lower price.
There is merit in averaging down the price provided the stock’s fundamentals are strong and the current drop is external to the company or owing to a temporary event. If your bet is right, the upside on the investment will be much higher.
However, if the fundamentals have deteriorated, then averaging is like catching a falling knife; your losses will only worsen as you buy more of the same junk. Kunj Bansal, ED & CIO, Centrum Wealth, argues there is no point throwing good money after bad. “Averaging down is a good idea only if the underlying stock is of good quality. Even then, fix a limit to the extent to which you want to increase exposure,” he says.
“Averaging is a good idea if the stock is of good quality. Even then, fix limits.” Kunj Bansal, ED & CIO, Centrum Wealth
3. Falling for confirmation bias
WHEN THEIR stocks go into a tailspin, investors start devouring investment news and research reports. But they also seek information or signals which support their beliefs and tend to ignore matter that refutes their original thesis. This confirmation bias works overtime during a falling market. It can distort your judgment of the situation and lead you to make a poor decision.
For instance, you may come across some post by an investor that vindicates your stand on the stocks. A research report may have looked at a stock in detail, but the confirmation bias will make the investor focus only on the optimistic portions. He will draw inferences on the basis of the statements that confirm his own thoughts. To avoid falling prey, don’t close your mind to negative information about the stocks you hold. Don’t let emotions cloud your judgement.
The biggest losers since 18 Sep when Nifty peaked
4. Buy scrips at 52-week low prices
A SLIDING market turns some investors into value pickers. They actively look for stocks trading near their 52-week low. These are perceived as good bargains since much of the downside is thought to be already captured in the price. However, some of these ‘opportunities’ may actually turn out to be value traps. First, it is very difficult to pinpoint when a stock has bottomed out. As they say, the market can remain irrational for much longer than you can remain solvent.
Even if it is a high conviction bet, one must be prepared to digest losses in the near term. The market may take time to recognise the value in the stock. Vikas Gupta, CEO, OmniScience Capital, says, “The 52-week low may provide a starting point but would be a mistake if used in isolation.”
5. Taking leveraged bets
BROKERAGE HOUSES encourage investors to take leveraged bets. Margin investing and leverage can yield high returns, but also lead to big losses. This version of investing should be avoided at all times and particularly when markets are volatile. Taking leverage requires that the investment earn a return atleast equivalent to the rate of interest you are paying on the borrowed capital.
But with the high degree of uncertainty in stock markets over a short-medium term period, the investment may work either way. It may also bring emotions into play—if you are playing with money you can’t afford to lose, you may panic easily when the market dips. “If you are buying on margin, it limits your options and will be forced to close your position,” says Gupta.
6. Altering your financial plan
A SHARP fall in the market can lead investors to alter their financial plan or investment strategy. Some may be tempted to excessively ramp up exposure to equities to benefit from the market correction, while more conservative investors might deem fit to take out all the money to be on the safe side.
Don’t base your investment decisions or position the portfolio on prevailing market mood. The future course of the market may work out completely different. “At such times investors tend to forget asset allocation and lose patience. This can hamper wealth creation in the long term,” asserts Tarun Birani, Founder & CEO, TBNG Capital Advisors.
Instead of making knee-jerk changes in the strategy, it makes sense to focus on the long-term objectives and stick diligently to a well-defined financial roadmap.
“Don’t lose sight of your asset allocation or lose patience at such times.” Tarun Birani, founder & CEO, TBNG Capital
7. Stopping SIPs because of the fall
ONE COMMON mistake that small investors make is to stop their systematic investment plan (SIPs) in equity funds when markets tumble. This defeats the very purpose of the SIP. A bearish phase is precisely the time when sticking to the SIP discipline will help you achieve your long-term goals.
You will be buying more units at lower prices and reap benefits when the markets eventually rebound. Stopping the SIP will not only interrupt the compounding benefit of equities but also leave you with a shortfall in your target corpus.
For those who have just started their SIP journey, it is even more critical that they remain invested for the long term and not get swayed by market sentiments. Anil Chopra, Group CEO and Director, Bajaj Capital, says those waiting for better entry point are likely to miss the bus. “Timing the market is a futile exercise. Staying out of the market is a greater risk than being invested in the market.”
“Timing the market is futile. Staying out of the market is a greater risk.” Anil Chopra Group Director, Bajaj Capital
8. Over-diversify the stocks portfolio
MUTUAL FUNDS diversify to reduce the risk, but individual investors usually bet big on a few stocks. Such focused exposure can hurt when the tide turns. At the same time, too much diversification is also not good. Some investors may try to reduce the risk by spreading their money across several sectors or even multiple companies within a sector at once.
Sure, this will help you temporarily limit the downside and cushion your overall portfolio. But it will also prevent you from gaining meaningfully when the market recovers. Diversification is essential but beyond a point, it will not lessen the risk any further. Also, you will find it difficult to monitor a large number of stocks.