Posted On 12 Mar 2020
Imagine a scenario when your stock price has taken a drop and the market has not been looking good. Do you sell your stock to prevent further loss or do you stand still and wait it out?
To answer this question it is important to revisit some basics. Note that the point of investing is to buy low and sell high as this is the formula by which investors earn from the stocks they purchase. On top of this basic rule, it is also important to know and understand how the market works.
The market ideally, is self-correcting. This means that as the stocks are traded, the rule of supply and demand will take its course. When the price of a stock is rising, people will buy due to perceived high demand. In return, supply will shorten and the value of the stock will rise. When the stock hits its cap, investors will then perceive a decline and start to sell. In the advent of overvaluation, the market will experience a market correction that is characterized by a drop in the market.
Unfortunately, many investors let their emotions get the best of them during a market correction. Precisely stated in the example above, when the market is doing good, people will tend to buy and thus create inflated prices. Once the market corrects, and the market drops, people start to sell, when according to the basics they should be buying when the prices are low.
Ideally, it helps to look at investments as long term portfolios. The buy-and-hold approach would tell a wise investment to buy your stocks and hold on to them regardless of whether the market drops or not.
Often a market correction is associated with a bear market. While it does not always mark one, it can definitely precede one. A bear market is characterized by a period of stock prices consistently declining. This period may last for several months to years. To an average investor, this might be a good time to panic. Imagine going through months of constant decline in the value of your money. That’s what an average investor would think, but a wise investor would look at this another way. This could be a good time to buy.
What to buy is another thorough discussion altogether. It would require a test in your fundamental analysis of the stocks you wish to buy. A good review of the performance of the company would help you build your confidence to buy a stock, even if the market might seem like it’s not performing well.
For example, even if the market is going down, you checked that Utilities Company X is selling at 35.5. You checked the news and you found out that Utilities Company X is set to expand its coverage due to a bill recently passed in Congress. You decide to buy 100 shares at 35 the following day. After six months, the market corrects and you see a return in your investment as the stock value goes up to 50. That’s not a far off scenario in the real market.
In the end, you should consider why you invested in stocks, to begin with. Did you invest in long term gains? If yes, then changing your investment strategy because of short term correction in the market might not be a wise move. It is best to think long term. This can be backed up by a thorough understanding and confidence-building in your portfolio. Do not be impulsive in converting your paper losses to actual losses by selling just because the market is going down.
At the end of the day, it pays to quietly observe and do nothing, and wait until the market has corrected or has improved.