Stock market correction is a scary time in an investor’s life. All the hard-earned profits suddenly erode during a correction increasing the fear amongst investors. Even hardcore long-term investors begin to struggle with the idea of holding stocks and start to sell. What should an investor do in a market correction? And which mistakes should an investor avoid during a market correction?
DO’s
1. Hold your stocks
The very first thing to understand about the stock market is that corrections and crashes are part of the investment game. On an average, a correction can be observed every 6 months and a crash can be observed every 6 years in the stock market. Market corrections can happen because of multiple reasons but they eventually go away! The biggest mistake which investors make is selling their stocks in panic during a market correction. The best strategy during a correction is to hold onto your long-term portfolio because the markets tend to be bullish in the long-term. Here is a chart of Nifty 50 for the last 5 years.
Nifty has corrected multiple times and even crashed once during the Coronavirus pandemic. However, the markets always bounce back regardless of how grim the situation appears. Always hold your stocks during a market correction as a long-term investor!
2. Switch towards fundamentally strong stocks
A market correction offers investors a good time to rebalance their portfolio because their favourite stocks are available at a sale. Every investor has some stocks which he/she always wanted to add to their portfolio due to their amazing business model and growth potential but were never able to find a good opportunity to do so. Market corrections provide an amazing opportunity to remove fundamentally weak stocks from your portfolio and enter into fundamentally good stocks.
However, many investors make the mistake of doing the exact opposite. Suppose a fundamentally strong stock has fallen 15% during a market correction & a fundamentally weak stock has fallen 25% during a correction, investors start switching towards the weaker stock because it appears cheap. This is a big mistake! The biggest discounts are always available on the crappiest products. The exact same is true for stocks!
3. Focus on the market leaders
Stock selection during a market should always be biased towards market leaders. These are large-cap companies with trustworthy management which have grown to become market leaders in their respective industry. Most Nifty 50 companies are market leaders in their industries. Such companies provide a safe investment opportunity during a market correction because they are much more stable during high volatility. Also, these companies are almost always the first ones to recover after a market correction.
Think of it this way – if Reliance Industries and some unknown company are both available at a discount, which one would you prefer? Surely, most people would choose Reliance Industries over an unknown company. This is the exact reason why the market leaders recover the fastest post a market correction.
DON’TS
1. Lumpsum investment
Nobody can predict the bottom of the stock market! Despite many claims which people make about their successful prediction of the bottom of the stock market, it is simply not possible to make such predictions. To learn more about why nobody can predict the stock market, visit this article!
Lumpsum investment becomes dangerous during a market correction because nobody knows when the bloodbath will stop. If you use all your capital to buy stocks during a 10% correction, what is going to happen if the correction increases to 20% or more? Buying stocks in tranches (both during the downfall & the post-fall rally) will allow an investor to make proper use of a market correction.
2. Selling profitable stocks, keeping loss making stocks
This is a common mistake amongst new retail investors. Investors sell profitable stocks to average their loss making stocks. Or even worse, they sell their profitable stocks to get “some money out of the market”. This is a really bad strategy in the long term! Stocks do not care if you are making a profit or a loss. They simply move based on technical analysis in the short term and fundamental analysis in the long term.
Suppose stock A is providing you 10% profit and stock B is giving you a 10% loss, many investors make the mistake of selling stock A & “averaging” stock B. This is a huge mistake! To learn more about why this should be avoided, read this article – Why ‘average’ thinking doesn’t work in stock market?
Just the fact that a stock is giving you profit doesn’t make it a good sell candidate. Similarly, just because a stock is giving you a loss, doesn’t make it a good buy candidate. The entire idea of re-building the portfolio should be to switch towards companies which are better suited for growth in the future.
3. Avoid leverage
Many investors make the right decision of buying stocks during a market correction. However, some investors go overboard when buying stocks and end up taking highly leveraged stock positions. This mistake should be absolutely avoided! Even though a market correction is a great time to invest into the stock market, nobody knows about the bottom of the market. A market correction can even turn into a market crash which can cause immense loss to a highly-leveraged investor. Adding leverage to a portfolio can easily turn a good situation into a terrible one.
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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