Market corrections are the true test for a long term investor. It can be a very scary time where most investors run away from the stock market & never return again due to the fear of losing all of their hard earned money. However, these corrections can be an amazing time for a patient long-term investor to invest their money in the stock market since everything is available on sale. It is also a great time for investors to rebalance their portfolio since their favourite shares which they always wanted to buy, are available at a heavy discount. But there is a big mistake which investors make during a market correction!
The mistake – “Selling your winning stocks while holding onto your losing stocks.” Most people see market corrections as an opportunity to sell their stocks which are in green (currently in profit) & keep on holding stocks which are in red (currently in loss). Let’s look at all the reasons why this is a huge mistake.
1. The stock doesn’t care about your buy price!
If you bought a good stock in 2008, then there is a high probability that the stock will be much higher than your buy price in 2022 which means that you are in a highly profitable situation. However, if you bought a stock 6 months back, it is entirely possible that the stock will not be higher than your buy price. In fact, during a correction it is completely possible that the stock might be lower than your buy price. Does that really mean that you should sell the profitable stock (one which you have been holding since 2008) and keep on holding the losing stock? NO!
This doesn’t make any sense because the stock doesn’t care about your buy price. A stock moves based on its fundamentals in the long run & technical analysis in the short run. To learn more about how stocks move, visit this article! The only thing which you need to consider is the future of the stock. And that doesn’t depend on your buy price!
2. Strong stocks don’t fall a lot during market corrections
Selling a profitable stock can often mean that you are selling stocks which are very strong during a market correction. Think about it! The stocks which fall less during the market correction are showing you the capability that they are strong stocks because their demand is high even during a market correction. However, using the policy of “Sell whatever is GREEN”, we end up selling the strongest stocks.
If a stock falls only 10% when the market falls 25%, that means the stock is very strong because investors are not willing to let go of this stock. On the other hand, if a stock falls 50% when the market falls 25%, that means the stock is very weak because investors are running away as soon as panic hits. It is not wise to sell all strong stocks and end up with the weakest stocks of the market correction.
3. The next rally is inevitable
The market correction is always followed by a strong rally (if the uptrend continues). This rally will generally see the strongest shares perform the best. Those strong shares are often the same strong shares which fell the least during the market correction, which the retailers sold from their portfolio to get meagre profits. The weak stocks from which everybody was running away from during the market correction generally tend to be amongst the worst performers in the next rally. And funny enough, most retailers hold onto such shares because they kept all the losers with them. This causes them to lose out on the potential gains in the follow-up rally giving them essentially a poor return for all the patience shown to hold onto the stocks.
What can an investor do about it?
Always rebalance your portfolio by keeping in mind the future of the stock. It doesn’t matter if the stock is in green or red because that depends only on your buy timing, not on the stock’s future journey. It is not wise to sell a stock just because it is the only profitable stock which you have. Always remember, the strong stocks are the ones which hold firm during the market correction & are generally the first ones to rise!
If one investor has Reliance Industries in his/her portfolio with a buy price of Rs. 100 whereas another investor has the same stock with a buy price of Rs. 2600, there should be no difference between the approach of the two investors. It is the stock’s journey to the future which matters, not your buy price!
Think as if you don’t own any stocks & want to build a brand new portfolio during the correction. This will remove any favourites & will only focus on the quality of the stock. Also, this will remove most weak stocks & will allow you to hold onto strong stocks.
Conclusion
It doesn’t matter if the stock is green or red. The only thing which matters is the strength of the stock & the future potential of the stock. Your buy price is only your concern, the stock doesn’t care about your buy price. It is generally unwise to rebalance the portfolio based on “green” or “red” in your portfolio. Instead, an objective look should be given to the stock based on their future projection. However, the final decision of investment depends entirely upon the reader.
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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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Thanks A lot for your expert comment and an eye opener too!!!