If the stock market looks too good to be true, it probably is!
Mumbai: After a prolonged rally, Chinese markets went bust. The Shanghai Composite index slumped 32% over the last one month compared with a 150% rise over the preceding 12 months. The decline was unexpected for many customers.
The Indian market last saw its steepest correction in early 2008, and currently does not seem to be in any big danger. But it’s best to be cautious at all times. Here are a few things that can help you identify whether a market could be headed for a correction.
You will find a lot of initial public offers (IPOs) in a booming market. Valuations are obviously high, but take that with a pinch of salt. While they may be genuine in most cases, you may find them outrageously high for not one but many of them at one go.
Everyone seems to know about the rally
There may be reason to worry when you find everyone, from your cab driver to your neighbourhood aunt to your co-travellers on public transport, talking about the “share bazaar”. You see many of your acquaintances starting to invest in the markets, or worse getting into day trading, and actually making money.
Too much optimism
You may need to pause when the ‘feel-good’ factor is running high: The economic growth projections are high, the number of queries (not orders) coming to brokerage firms have increased, there is not a single word of caution anywhere on TV debates and news anchors are enthusiastic about each new milestone that the market crosses.
When all of this happens together, it could be an indication of a correction. Even if it’s not significant, it could hit valuations nevertheless.
Retail investors start taking risk
When you see retail investors postponing important payments to trade in stocks or investing in IPOs, there may be trouble ahead. There are people who end up postponing insurance premiums or delaying children’s school fees and even taking debt to invest in the market.
Tips for unrealistic gains
When you find market investing tips floating around through word of mouth, messages and media reports, and find these tips tempting, it’s best to check whether they are worth it. At such times, penny stocks flourish. Stocks that return 25% a year do not excite investors, who start looking for unrealistic returns of, say, 400-500% per annum.
Last but not the least, trust your instincts. If the market looks like it is too good to be true, it probably is going wrong somewhere.