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Concepts & Tutorials

How To Handle A Sinking Market

The mayhem is here. Nifty is down 183 points to 4345 and Sensex is down 615 points to 14935. A 4% drop in a single day of trade. Every single index is in the red, and nearly 90% of stocks are down today. Is it time for the bears? Is it time to exit? To go home and forget about stocks for a while?

First, let’s address the situation. What is this “fall”? The market rose vertically from near the 4000 levels in May to 4600 this month. Falling down to 4300 is not a big deal. The fear is the SUDDENNESS of the fall – I think none of us would be concerned as much if the market slowly went down over two months. But that is the nature of the market – it falls sharply, and rises slowly.

Why? Because a very large part of market participants, including FIIs, are driven by sentiment and momentum. That means on a short term (a day, a month, a quarter) markets move according to psychology rather than fundamental triggers.

Let me now try to explain why we fell, and more importantly, what you can do about it.

Markets in the U.S. fell 200 points yesterday. And most of this fall happened in the last two hours. The Asian markets moved wildly down (Japan, China, Taiwan) and then we followed suit in India. That’s it. There’s no story, no major problem, no threat, no trigger, nothing. Just bad sentiment.

Why the market slid is not important. The fact that it did is. You now have to react to this slide. How?

Question: Are you in the market for the really long term and don’t care about your portfolio for the next few years? Stop reading here. This is where you shouldn’t bother. Nothing has changed from yesterday to today, except a CRR hike, which is another short term thing. Take some rest, and watch cartoon network or Pogo for a while.

But for the rest of you that are active investors: What can you do? You’ve probably seen some of your stocks down 10%. Still, you’re probably profitable because let’s face it, this bull ride started four months ago. You want to protect your profits, but how?

Here’s my points:

  • React to the markets. Don’t try to predict them. In times of volatility you can never say what will happen unless it has already happened. People will give you conflicting opinions – and someone will say this is temporary and others will say it’ll go down forever. Forget them. What matters is how you react, not what other people think.
  • The trend is your friend. Meaning, if the trend is down, sell. If the trend is up, buy. As an example: The markets opened more than 2% down today. Half an hour later it was still down on heavy volume. That’s as good a sell trigger as I know. If you had short sold the Nifty future then, you could have covered most of your losses in the underlying stocks by the end of the day.
  • Respect your stop losses. You bought stocks for a reason. That they will rise in value. When they fall, they are going against your reasoning. Keep a limit on how much you lose and take the loss when the stock goes there. For instance, BHEL is a great stock. Fantastic long term prospects. Still, when it fell from 1890 to 1700 in a few days I sold the stock. It could be a great company, but when the stock falls 10% without proper reason, what is the assurance it will not fall ANOTHER 10% without reason? Most of the time stocks retrace MUCH more. So I would rather exit the stock than see my money go down another 10%. (Note: My stop losses are usually 20% because of Indian market volatility. BHEL was a special case: When my stocks reach 50% above the level I bought at, I cut my stop loss down to 10% from the highs)
  • You can never make money from the first 10% slide. It will be a surprise, regardless of how good an investor you are. You need to make money from the NEXT 10% fall, which will happen because of the panic in the markets. You can thus recover what you made. But how? Buying put options, selling call options or selling futures.
    If you do this, you must be careful and track the markets closely, so that you cover any losses. If you short sell a Nifty future (Rs. 16,000 margin) and it goes up 32 points, you’ve lost 10% of your margin – so you need to cover.

  • Don’t buy on the way down. Buy on the way up. Meaning, if a stock is falling and you like the price, don’t buy it yet. Let it reach its lows, retrace back up say 5% and then buy. That way you don’t catch a falling knife.
  • There are ways you can make “income” from the volatility. This involves using bear put spreads, writing straddles and writing calls. Another way is to buy way out-of-the-money puts and calls, knowing that whatever happens, the market is either going to be up sharply, or down sharply, which gives you an upside either ways (since you buy both a put and a call). This strategy requires explanation, so let me explain that in another post. But suffice it to say that there are ways for all of us to make money using futures and options even in a downturn.

Now let me tell you what factors might impact the market:

  1. CRR hike of 0.5%. People say this will not impact lending rates but that is baloney. Fixed deposits are already booked. You can’t change those rates. Floating rate loans can still be moved. So what do you think a bank will do? Most likely lending interest rates are going up. Meaning, bad for auto and real estate.
  2. Money flow: If the US markets go down, FIIs are likely to take their money out of India, because their investors may panic, or because they want to invest back in the US. Either ways, money will flow out of India. How will you know? See the dollar. if it keeps rising to Rs. 41 per dollar or more, money is flowing out.
  3. Panic: Every single bear market was created out of panic. When panic selling happens, the market moves FAST, spiralling downwards. You can’t predict panic, you can only react to it. If you will participate in the next few days watch out for panic.

But don’t do any random trading. Think about why you are in the market, and stay disciplined. It’s easier said than done, but if you don’t say it, you won’t do it.

What am I going to do? I’ve been actively protecting my portfolio and have been seriously in cash (nothing to invest in since I sold BHEL and Balaji) – so I’m doing some F&O strategies to test our markets. We’re writing software to analyse patterns, and what better time to test our patterns than in such times! Once we have our analysis, I will show you how you can make money at such times as well.

  • Anonymous says:

    >CESC has the potential to become next BHEL…

  • Siva says:

    >Thanks.
    When u recommended to sell BHEL at 1700, I wanted to wait. But, y’day, successfully sold at 1700+
    Thanks for your analysis.
    Please explain in details future/options, call,put,etc

  • Siva says:

    >i want to buy exchange tradable Govt bonds-Bhavishya NirmanBOnds.If you have any idea, pls post in your blog.

  • Kunal Bhasin says:

    >Hi,

    look forward for new things…

    Kunal

  • Guruprasad says:

    >Hi,

    It’s amazing that you’ve not predicted that downfall in a proper manner which is related to Subprime Lending. It’s sad that you’ve not written anything about Subprime debacle, which is hot, hotter and hottest topic across corridors in almost all broking circles all over the world. If a person is a long term investor, he won’t bother to look your advice and Ofcourse anyone for that matter. People like you are writing only for active investors and that’s how you’re getting highlighted in the circles of capital markets. You said there is nothing in the fall. I believe that you’ve not predicted (I’m not sure) the beginning for the end of Bull Run in India. I believe it’s premature to say at this point of time, just because markets are slipping in red. There is no doubt that India’s growth story is intact. No question about this. But I hope you’d understand that it’s FIIs who’re ruling the roost in our markets. If the pull back couple of billion dollars, I don’t think market would move quickly from current levels. Even today from below of around 4201(nifty futures) it came to 4300. But it doesn’t mean its recovery. I strongly believe that people have increased their selling average by the way of this pull back. I don’t think anyone could clearly judge how to play in sinking markets and Ofcourse so called investment gurus who’re appearing in National Business Channels. No one knows what the problem with Subprime is. We saw volunteer cash pumping from Central Banks (ECB, Fed, BOJ and others) during September 9/11. After that we’re seeing now. This clearly shows that something is wrong, which hasn’t been said by guys who’ve suffered most due to murky Subprime lending. Liquidity is the name of the game. If we (including me) are smart we could come to conclusion that there is something wrong in erratic movements that happened in US markets which was really new for the last 6 months, in which markets tumbled also because of Subprime losses(Approx $6.4Billion) reported by ABN Amro. No one seems to accept (Ofcourse not wiling to do) that widespread problem of Subprime. Almost all the brokers across India said that Subprime has nothing to do with Indian markets and its just 2% of whole banking industry. But now after all those bullshits we’re witnessing this meltdown. India must learn to grow without FIIs who’re nothing but greedy individuals who’d love to speak industry lingo and do nothing but messing with markets through Television Channels and Newspapers. Would this happen? Only time will tell.

  • Deepak Shenoy says:

    >guruprasad: I’m not sure how much subprime lending will affect us. There’s not much exposure to that debt here in India.

    One issue will remain: Global interest upmoves will affect the bottomlines of some of these companies, and the new ECB rules are going to increase the debt pressure. Still, there’snot so much debt in the top 50 that would be a matter of concern.

    Bull runs always end abruptly. I’ve talked about how this market is enormously overvalued, but also that this is a
    sign of irrational exuberance
    .

    You shouldn’t get out of the markets because it’s bearish. When it’s volatile, it can still be a good time to invest.

    Subprime may not affect us directly, but yes, FIIs will tend to pull out. I would shy away of predicting a fall now or tomorrow, because you should not predict in a volatile market – look at the trend and go with it. Keep your stop losses handy.

  • Guruprasad says:

    >Hi Deepak,
    Could you give us a gyan on ECB(this time, External Commercial Borrowings) and how it affects companies to raise money outside India plus impact of rupee.Please write an article, so that people like me could understand more about this. Thanks.