10 common mistakes to avoid in a falling market

Trying to catch the bottom in a falling market is the most common mistake investors make.

Sep 09, 2019 08:09 IST India Infoline News Service

The stock market has seen a sharp correction over the past month, making investors anxious and jittery. It is often during a sliding market that investors make ill-advised moves and end up paying a heavy price. With a carnage of this magnitude, it is not just the money that the investors lose, it is the confidence that gets shaken.

Here are a few common mistakes that investors should avoid in such situations:
  1. Trying to catch the bottom: In a falling market, no one knows what the exact top or bottom will be. Hence, instead of trying to predict the bottom, investors should determine the value and target price of any stock in which they intend to invest by whichever method they follow, i.e., fundamental, technical, etc. and then buy it within 5% to 10% range of that buy price.” Remember, if you wait too long to buy, until every uncertainty is removed and every doubt is lifted at the bottom of a market cycle, you may keep waiting.
  2. Confirmation bias: When stocks go into a tailspin, investors start devouring investment news and research reports. However, they also seek information or signals which support their beliefs and tend to ignore data that refutes their original thesis. This confirmation bias works overtime during a falling market and can distort your judgment of the situation and lead you to make a poor decision.
  3. Impatience: Patience is one of the keys to success in the stock market. The only thing that you need to do in the stock market is to buy good stocks and give them time to grow. However, most people who lose money in the stock market are those that do not have patience. Although many of these people are able to find a good stock, they are not able to make a sizable profit from the investment because they don’t hold on when times are tough. In fact, if the reason for the fall in price has to do with external factors rather than a change in the fundamentals of the stocks, holding the stocks for a some more time may prove to be fruitful.
  4. Changing long-term strategy: It is usually during a bear market that investors try to change their investment strategy overwhelmed by panic. This undermines the long-term strategy which will slow down the pace of achieve one’s financial objective. The effective way to tackle this short-term event is by building a portfolio which is sustainable in the long run.
  5. Obsessing over markets: Investors have access to 24 hours of endless stock market media coverage. During times of market downturns, almost all the coverage will be negative. Exposing yourself to hours of negative market news everyday can impact your sentiment in irrational ways. It can make you doubt your own thesis, even if it is based on solid facts. So, it is better not to obsess over the bad news and discount the good news when markets are in correction mode.
  6. Increasing margin bets: Margin investing and leverage can yield high returns, but also lead to big losses. This version of investing should be avoided at all times, and particularly when markets are volatile. Taking leverage requires that the investment earn a return at least equivalent to the rate of interest you are paying on the borrowed capital.
  7. Overdiversifying: Some investors may try to reduce their risk by spreading their money across too many instruments, sectors, or even companies within a sector at once. Sure, this will help you temporarily limit the downside and cushion your overall portfolio, however, it will also prevent you from gaining meaningfully when the market recovers.
  8. Getting caught in a value trap:  Value trap implies getting trapped in a stock whose price seemed very attractive when you invested, but it continues to remain low for a long period of time, because it wasn’t very valuable after all. Even seasoned investors tend to make the mistake of buying a stock because it has fallen sharply. What declines the most need not bounce back the most. The stock price is just a quote in the market, and, on its own, does not have any significance whatsoever. It has to be measured in conjunction with the company’s performance, earnings, book value, dividends, etc. A high-priced stock may actually be cheap on a valuation basis, while a low-priced penny stock may actually be very costly if the underlying business does not support that price.
  9. Emotions clouding judgement: The first thing which people do when they face a loss is increase their lot size for quick recovery. As a matter of fact, if you made a loss earlier, there is no guarantee that you won’t make it again. When it comes to money, either of the three emotions dominate us: greed, hope, and fear. Most people lose money or fail to gain in the stock market not due to lack of intelligence, but due to the inability of controlling emotions while making an investment decision.
  10. Buying stocks that buck the trend: In a bear market, there will always be stocks that move in the opposite direction. Many investors see the price movement as an affirmation of its qualitative strength without bothering to analyze the stock.  Thus, they could end up with a stock that is too expensive or a mediocre stock that was reacting to a company/sector specific update.

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