During volatile times, many investors get spooked and begin to question their investment strategies. This is especially true for novice investors, who can often be tempted to pull out of the market altogether and wait on the sidelines until it seems safe to dive back in.
The thing to realize is that market volatility is inevitable. It’s the nature of the markets to move up and down over the short-term. Trying to time the market is extremely difficult. Even long-term investors should know about volatile markets and the steps that can help them weather this volatility.
Volatile markets are usually characterized by wide price fluctuations and heavy trading. They often result from an imbalance of trade orders in one direction (for example, all buys and no sells or more sells and less buys).
One explanation is that investor reactions are caused by psychological forces. This theory flies in the face of efficient market hypothesis (EMH), which states that market prices are correct and adjust to reflect all information. This behavioural approach says that substantial price changes (volatility) result from a collective change of mind by the investing public.
It’s clear there is no consensus on what causes volatility, however, because volatility exists, investors must develop ways to deal with it!
Beat the myths !
√ Long-term investing still requires homework because markets are driven by corporate fundamentals. If you find a company with a strong balance sheet and consistent earnings, the short-term fluctuations won’t affect the long-term value of the company.
‽ One common myth about a buy-and-hold strategy is that- Holding a stock for 20 years is what will make you money.
In fact, periods of volatility could be a great time to buy if you believe a company is good for the long-term !
‽ Large cap stocks are sure bets
√ While companies with a long track record and an established business make for attractive investments, they may not turn out to be fast appreciating stocks.
One of the reasons is that these stocks have already given a decent return in the past and have a higher base.
Secondly, such stocks are widely covered by a number of analysts. As a result, the ability to generate excess returns is severely limited.
‽ If the stock has done well in the past, it must do well in the future too…
√ Warren Buffet often jokes that if the past was what the market was all about, then librarians and archaeologists would be the wealthiest people in the world. Volatile markets can be as testing and cruel on old stocks as well as newbies.
‽What Goes Up Must Come Down
√ The stock market operates by itself driven by performance, demand, potential and stability or ‘financial soundness’ and no laws can be applied to it.
Bear markets do happen but bullish markets are equally common.
The stock prices are a reflection of investor sentiment and the potential of a company in an industry. You have to find a company with an excellent management team that has a stock price on an upward trend and it will continue to be on an upward trend. The selection is extremely important.
How to weather the storm!!
Only when the tide goes out do you know who has been swimming naked, Warren Buffett once said. This is apt for so many investors who jump into bull markets, throwing caution to the wind.
- Invest in stocks that multiply in value, the chase should not be about participating in stocks that are currently ‘the flavour of the market’.
- To own multi-baggers, you have to hold your stocks for months, if not years. This requires a lot of patience and determination. More importantly, this requires painstaking research before investing. Only then can you be sure of the quality of your investments even when markets churn.
- Imagine this scenario: you have a portfolio of nearly 25-30 stocks that have, on average, returned 15% every year in the past. But you want more. So you ask your broker friend to look at your portfolio and tell you what is wrong. One must realise that it’s not about earning higher returns than other people. It’s about outperforming the market.
- Look at its price-to-earnings ratio to evaluate. This helps you understand how many rupees you are paying for every rupee of profit earned. The higher it is, the costlier the stock.
- Diversify … diversify … diversify – An allocation to small-cap, midcap, and large-cap stocks also provides exposure to companies of various sizes.
- Consider SIPs – Investors who do stock SIP do not want to take any chance during volatility and take the benefit of averaging and are sure of the medium term or long-term potential for appreciation in the stocks. Through stock SIPs, investors can accumulate stock over a longer term and iron out stock price volatility.
- Buy at the lower end of the range and sell at the upper end of the range. You could also short at the upper range and cover your profits at the lower range if you are adept at switching positions without getting emotional about them.
- Timing the market is not easy and if you are not confident about taking advantage of volatility, you should avoid it. Take the opportunity to move out of equities and invest in debt ( or other alternatives ) until an upward trend is established. You can re-enter the market when there is more certainty.
Timing the market or time – in – the market?
For the common man, both are equally intimidating. But which of these is the “right” way of investing?
The most common is, tactical and technical timing. Buy/sell decisions are based on either price movements or, in a more evolved form, on various technical parameters. The price-earnings (PE) ratio is often preferred. The rule here is simple, buy when the PE ratio is low and sell when it is high. The rewards of doing this systematically can be substantial.
On the other hand, for those who believe in time-in-the-market – Median returns generated by investments across various time periods are a good indicator of the rewards of “time in the market”. Median returns are satisfactory once a threshold of five years has been crossed. As expected, the case for patient investing is a strong one. Data show that the chances of loss lessen with more time spent in the market
The unequivocal answer to the question, therefore, is simple. A rewarding investment experience needs both, because the ability to spend the required “time in the market” needs good “market timing”.
Investing discipline will allow you to naturally ‘buy at lows and sell at highs’ and win over the emotions of greed and fear.
Dilzer Consultants Pvt Ltd