Markets don’t shift from rally to correction overnight giving enough time to set up a defensive game plan
ANUPAM SINGHI | Wed, 21 Jun 2017-07:25am | DNA
The stock market is one of the most powerful wealth-creating engines ever invented. During a bull market, one can generate significant profits, and similarly, when markets correct, investors can lose all the gains and run into losses in the absence of defensive plan in place.
Expert research and studies suggest that three of the four stocks will eventually follow the market’s trend, so you would want to be sure you are swimming with the tide and not against it. However, if you just blindly follow a “buy and hold” approach, and don’t follow where the markets are heading to, it is very likely that all those gains will disappear.
Fortunately, there are many research based time-tested ways to step off that rollercoaster and profit from the market cycles. It is important for you as an investor to understand the current condition of the market and look for alerts for any changes in trend. Markets don’t shift from rally to correction overnight. It often takes them few weeks, giving one enough time to set up a defensive game plan. By systematically spotting market tops, one can lock in gains and avoid big losses when market enters correction.
It is observed that a growth of at least 25% is a good starting point; the bigger the earnings in the latest reported period, the better is the stock. When buying stocks investors should prefer stocks with current quarterly earnings and annual earning of at least 25% in the past three years. Investors should look out for any positive change in companies. It could be a new improved product or service. It could be a favorable macro-economic condition in the industry; or a change in leadership. All such factors can catalyse the stock to go higher, as they can make a positive impact on the earnings of a company.
As an investor, you have to understand that mutual funds, banks, and other professional investors play a major role in driving the market. It is observed that institutional support boosts the stock prices and a stock turns to be a top performer. You should look for heavy volume movements, which indicate that institutional investors are accumulating stocks.
Technical analysis needs to be done to spot weak and volatile stocks. Leading stocks are bellwether for the overall market. When they show weakness, the overall market is not far behind. To make money over the long term, you need to protect your profits when a downturn hits.
During a market downturn, the odds of success are not in your favour, so following a defensive game plan during correction, can help you safeguard the gains and also cut short the losses. You are better off waiting for the next uptrend to begin before making new purchases. You should consider selling your weaker holdings. If you own a stock that is selling off and you are sitting on a small loss or at break-even, you may want to reduce your exposure. It’s advisable to sell if a stock drops 7% – 8% below what you paid for it. Cutting losses at 8% can save investors from huge losses like in the case of Satyam.
It is good to hold on to the gains and book most of the gains after the stock has run up by 20%-25%, since most equities consolidate near that point. However, as an exception, if a stock rises 20% in just one to three weeks, it should be held for at least eight weeks.
Many investors get discouraged during a downtrend, and give up on the market. Big mistake!
Investors should preserve their capital from deep losses by having a strict stop loss. Corrections are healthy for stocks as many leading stocks build bases during market downtrends. They eventually break out and launch new moves when markets make a strong comeback.
So to catch those big gains, it is absolutely essential that you should prepare a watch list while the market is still down. A perfect blend of fundamental and technical analysis should be followed to find leading growth stocks.
SOLUTIONS IN HAND
- Markets don’t shift from rally to correction overnight giving enough time to set up a defensive game plan
- Investors should look out for any positive change in companies which can catalyse the stock to go higher
The writer is chief operating officer, William O’Neil India