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How to manage stock market volatility

One risk that is rarely spoken of, or acknowledged by investors is an investor's own thoughts and behaviour

In investing, what is comfortable is rarely profitable," said Robert Arnott, an American investor who advises on investments of over $200 billion. When volatility surges, people often want to know about future stock prices. They want to know when the market valuation would get comfortable for them to buy or sell. They also want to assess the risk involved in making a move at that time. But there’s another risk that is rarely spoken of, or acknowledged by investors—an investor’s own thoughts and behaviour. 

This often causes more harm. After all, you can ride stock market’s volatility by buying and holding for the long term (assuming you purchased a good stock). But how can you avoid the risk of poor decisions? These are, after all, finite and cannot be changed. Here are a few of the common mistakes that I have noticed investors make:

Only when the tide goes out do you know who has been swimming naked, the famous investor Warren Buffett once said. This is apt for so many investors who jump into buoyant markets, throwing caution to the wind. Well-defined principles of investing and a sense of risk are left outside the gate, and stocks are bought purely to chase momentum and for bragging rights. Instead of opting to invest in stocks that multiply in value, the chase is about participating in stocks that are currently ‘the flavour of the market’. And yet, this enthusiasm and risk-taking behaviour disappears the moment markets start correcting. The investor is then left in the wake of destruction, questioning his investments. Even steady investors freeze their investments and put their discipline on hold. 

What to do instead: The reality is that to own multi-baggers, you have to hold your stocks for months, if not years. This requires a lot of patience and determination. More importantly, this requires painstaking research before investing. Only then can you be sure of the quality of your investments even when markets churn. 

Imagine this scenario: you have a portfolio of nearly 25-30 stocks that have, on average, returned 15% every year in the past. But you want more. So you ask your broker friend to look at your portfolio and tell you what is wrong. He recommends selling half the stocks and suggests other stocks to buy instead. What would you do? Many investors, erroneously so, believe that the stocks recommended by a friend or a competing brokerage house are better than the stocks they already own or those recommended by their financial adviser. After all, these stocks are not giving as much returns as their friend, colleague or neighbour gets. 

What to do instead: One must realise that it’s not about earning higher returns than other people. It’s about outperforming the market. In the last 24-odd months, when markets have been benign, investors who have bought consistently on every dip have come out winners. However, do note that even after a stock price dips, it may not be ‘cheap’. Look at its price-to-earnings ratio to confirm this. This helps you understand how many rupees you are paying for every rupee of profit earned. The higher it is, the costlier the stock. 

Do you know why many investors ‘buy and hold’? It’s not because they have a particular target in mind. They may not even have the ‘investment duration’ in mind while buying the stock. More often than not, the reason is to hold on until the losses turn into gains. 

The corollary to this fallacy is even more interesting—an investor may have bought a stock from a long-term point of view. But after 25 months she notices that the stock is giving her a 500% return. Suddenly, when the winds of a market correction start to blow, the investor fears she may never earn 500% again, and books the profit. Ten years later, however, the stock rises again to deliver a 1,500% return. This is like cutting the flowers to water the weeds. 

What to do instead: Equity investing is inherently risky. Prices can swing 10-15% on an average. This is when you see the change in value of your investments without having sold the stocks to book profits or losses. Don’t focus on notional gains or losses. You lose out on potential winners. While you may have read hundreds of success stories, first understand the sheer psychological strength required to hold on only for the right reasons. 

It is fashionable to be a contra investor or a value investor. This is when investors select sectors or stocks that are out of flavour. At such times, investors hope that eventually the sectors and stocks will return to their earlier glory. But such times can test the patience of even the most astute and seasoned investors. 

This is why it is best for investors to invest regularly across cycles with clarity of purpose. It is also important to carefully monitor the asset allocation periodically. Such discipline will allow you to naturally ‘buy at lows and sell at highs’ and win over the emotions of greed and fear. 

It’s inevitable to make mistakes. But what matters is that you don’t repeat them. This helps develop the confidence to invest successfully. 

Krishna Kumar Karwa is managing director, Emkay Global Financial Services Ltd.

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