The biggest joy in shopping is to find something at a discount. Be it an online shopping or physical shopping, the platforms are crowded to load up stuff at deep discounts. Let’s focus our attention on the stock market. It is just the opposite when it comes to buying the shares when they are marked down. People panic during the sale season in stocks. Few of them sell their holdings while the rest are afraid to buy more due to despair from gloomy headlines. One of the most flawed concepts prevalent in the market is to judge a business by its share price or treating it an instrument to speculate. Buying a share in owning a part of a business that has to be bought by putting faith in the business model and the management running it.
Unfortunately, the optimistic voices of businessmen who understand their businesses better get overlooked by the clamor created by short term punters and journalists. For example, a slowdown in the auto sector in 2018-19 was caused by a liquidity crisis in the NBFC sector which lends against 30%+ auto volumes. This is not the first time that India is facing this cyclicality. A lot of categories are quite underpenetrated in the Indian economy to conclude that this slowdown is permanent. We would rather say that this car named India has not slowed because it’s out of fuel but because of speed breakers. However, current cacophony sends a message as if a car has crashed and would never revive.
What’s stopping you?
Especially in such situations when everyone is panicking, we experience a market correction. A market correction is 15-20% fall from the recent highs. A lot of good businesses are available at big discount but a layman may get carried away by the noise. He may mistakenly take unwise decisions to either make more money quickly or jump out of equity.
Here are some of the common mistakes an investor commits:
- “I am investing in Yes Bank since it is trading at its 52-week low which I think is cheaper price to invest in.”
- “I have seen a drastic downfall in PC Jewellers; I don’t want to sell it at this price. I would rather wait until it goes to my purchase price.”
- “I agree with ABC news channel that the Indian economy is going to collapse hence equity is the worst asset class to invest.”
- “Small caps stocks are the best source of returns since they have given almost 30% return in the last 3 years.”
- “I will start buying after some more correction happens.”
Why does this happen?
Now let’s find an ideal solution to deal with 5 different scenarios mentioned above:-
- In this case, an investor is avoiding the underlying reason that has led to a fall in Yes Bank stock price. In addition to that, he is anchored to a gap between 52-week low and 52-week assuming it to be a bargain. But instead, any company must be valued independently without looking at past and current stock price.
- This is one of the most common biases, called Loss Aversion. One thing to be understood here is- “You don’t have to make money the same way you have lost it.” The investor refrains from taking the loss despite knowing it was a mistake at the time of purchase. He may be missing out on the upside from other stock with great potential.
- An investor may have a certain belief about current market conditions and gravitate more towards the information that confirms the same belief. He may ignore data that is contrary to his existing opinion. This is called a Confirmation Bias. He might look at his own portfolio during the market correction (which is beaten down just like others’ portfolio) and will agree to pessimistic opinion floating around. This behavior makes him miss out on a bigger picture and makes illogical decisions hampering investment success.
- Just looking at the last 3 year data is a Sampling bias (looking at just one single 3 year period). This isn’t a true picture about small-cap stocks and there is no assurance that the last 3-year performance will be repeated exactly in a similar manner. There has been a 10-year phase from 2007-2017, small-cap didn’t earn any return, so one has to be cautious before committing large sums looking at short term returns.
- There is no one who can predict the future perfectly nor can anyone predict the exact stock price. Hence there is no need to panic or celebrate if the stock moves down or up respectively after the purchase. Stock prices would ideally move in lines with business in the long term, current movements are redundant in away. When there is an opportunity to make a decent return over time, one must capture it. Because most of the time waiting for the bottom, an investor may miss out on the swift rally in the market. This behavior of avoiding action leading to undesired outcomes is called Regret Aversion bias.
Things to do during a stock market correction
To circumvent the above-mentioned fallacies and successfully sail through the situation, the following 3 things are a must:-
- Spot Right stocks: – There are 5000 listed companies in the stock market. Which are good and which are bad? Well, a simple solution is to look at the Moneyworks4me color code. Where Green colored companies can be considered to investable and Red are to be ignored.
- Know the Right Price: – Buying price is a very important factor since that determines your total return in the long term. Just like your coupon code for a discount in online shopping, Moneyworks4me provides a discounted price to buy a particular stock.
- We have two prices in option-
i) MRP (the maximum price you should pay for the stock)
ii) DP (the discounted price you look for the stock to get in)
- We have two prices in option-
- Buy in Right amount to diversify: – The best method of risk reduction and sustainable wealth generation is diversifying the portfolio. Since we wouldn’t know the future in advance, by diversifying one reduces the exposure to a particular stock or a sector that may go downhill in the future. At Moneyworks4me we believe in holding a minimum of 20 stocks at any given point, thereby reducing the risk, volatility and ensuring long term wealth creation.
The overall idea is to get the maximum benefit from the temporary market correction (i.e. a car slowing on a road with speed breakers). You would not buy a Titan watch if it is double the price but you will definitely rush to buy the same watch available at a 50% discount. Shouldn’t this be the same while buying stocks when they are down so much?
Happy Investing! 🙂
Related Article: How to Emotionally Prepare for Stock Market Correction?
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