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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.

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