What If The Market Crashes?
Created on 19 May 2021
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Chance dictates outcomes. And howsoever experienced you might be, you can’t always tame lady luck! So, what to do in case the market crashes?
The rallying stock market has already offered a free ticket for a crazy roller coaster ride to each one of us. Now the rumors of an upcoming bubble or crash are just enough to make us all freeze with fear and anxiety. But we have a different opinion, and we would like to share it with you. Do you pledge to keep it a secret? Yeah? Then jump in.
The crash should essentially be viewed as an opportunity rather than a panic switch.
But how do you do that? Well, let’s find out. After all, it's not rocket science.
How to identify a crash?
Stock markets are that one subject where both the teachers and students fail to master. So predicting a crash is a hard nut to crack. No one was fortunate enough to predict all the previous ones perfectly. But the bear market does leave certain signs which an investor could notice and take some subtle steps to protect his wealth.
And the following are some of them.
An investor should look into the previous records of price movements and draw comparisons with the situation prevailing in the current scenario. Just because a stock is trading at a high price does not necessarily guarantee credibility. In fact, a high stock valuation and record-breaking increases have always led to a crash. And history has repeated itself four times during the period starting 1929 to 2007. For instance, the dot-com crash succeeded in highly-priced tech stocks.
Increasing credit tension
Crashes usually occur when there is a lot of money in circulation. So whenever the interest rates are low, there is a high chance of a market crash.
Yes, you are right. More money means more growth. But on the other hand, it might end up over-flooding one particular sector only to give rise to another crash. Also, the credit valuation of the same plays an important role. The subprime loan crisis was a perfect example of the same. Lower interest rates prompted people to borrow abundantly, only to default in the due payment and ultimately causing a crash.
'Too much of something is good for nothing.' As history says, every crash presented a disguise picture that all was happy and merry, just before the fall. So investors should understand that whenever there is too much optimism in the market, something terrible is brewing in the corner. Optimism makes the price rally and increase invariably than the fair value and ultimately lays the route to a crash.
So does that mean you should build up the walls every time one among the above pops up? Historically speaking, a fall of up to 10 to 20% is given in any year you take. Considering the long run, equities recover and will make up your losses. Every time the US stock market fell drastically, it came back stronger, fetching double the returns.
But anything beyond a 20% fall in the index should be a cause of concern.
What should you do?
So be it a normal fall or a stock market crash, an investor should keep the following things in mind. The below pointers might offer to minimize the losses and fetch better results.
A minor correction, irrespective of its impact on your portfolio, causes you to panic. This causes a chain of events, from making a bad decision to incurring losses. In the end, you would have cooked a perfect recipe for disaster. Hence whenever you notice a crash, the first step is to control your temptations and stay grounded. When covid hit the borders of India, the market showed immediate signs of crashing over 13.15% in a single day (March 2020). And the immediate response of the investors was to make some outrageous decisions that made them meet huge losses. So it’s better if you just do nothing for a while.
Avoid hurry selling
Selling every time the prices crash is a wrong move. It is essential that as an investor, you should control the urge to involve in mass selling. Not only does it bring losses, but it also grabs you of an opportunity where you can make profits if, say, the markets bounced back. It also gives place to unnecessary fear blinding you from reasoning. And as mentioned earlier, you will be benefited by holding them in the long run.
Buy, if you can
Market corrections and bear markets are the best time to buy stocks. These are ideal periods to buy those stocks which are of good quality and which are capable of fetching good returns. However, don’t try to calculate the bottom of the crash to enter into the market but simply choose those good stocks. Ensure you run a thorough study on your pick of shares before putting your money.
Rebalance when the worst is over
Once the heated market starts cooling down, you can start relooking on ways to minimize your losses and protect your portfolio. After a crash, the valuations might have changed, and new opportunities might have opened up. An investor should have a keen eye for these and ensure he reallocates his capital accordingly. He can also undertake hedging activities in order to protect his portfolio. Like, say, investing in gold, etc.
Always have a backup plan
While hoping for the best, always have a plan to compensate when things go wrong. Ensure you have enough cash to sustain even if your plans fail. In other words, consider your risk tolerance and profile and make plans accordingly. Look at the big picture and always invest for the long run.
You see, even when there is a market crash, it’s not uniform across all sectors. There would be some sectors that’ll be worst affected (for instance, hospitality sector during covid) and some that may rebound quickly (like pharma/IT sector in the said period). And you’d be foolish enough to allocate all your funds in one stock or sector. So, what to do, you ask?
Well, as we had written in a previous piece on Diversification - “[..] if you allocate your money across asset classes like equity, gold, debt, etc., and across sectors like Pharma, IT, Financial, FMCG, etc., that’s a better guard against market volatility. And as a standard practice, try limiting your exposure to 10-15% in any particular stock or sector.”
So there you go.
It is next to impossible to predict a fall. However, noticing the signs, one should take the necessary precautions. Further, making a minor change to the portfolio is recommended because taking any drastic steps might hurt your returns.
Lastly, remember to invest only after you have done your homework. Do proper research and find out a portfolio mix that works the best for you.
Anyway, what do you think? Is a bubble building up now? Tell us in the comments below.
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