Volatility is not the cause but the manifestation of the problem. Here are some basic things that you need to avoid when you are in the midst of volatile markets.
How do we define volatility in the stock market? Intuitively there are some clear indications of a volatile market. For example, in a volatile market your stop losses will get triggered both on the short side and the long side. In a volatile market, you find that your investment stocks are losing value more than they deserve. You will also find that volatility makes the VIX ratio shoots up, which is why it is also called the Fear Index. It shows the amount of fear in the market and that results in volatility. What we need to understand here is that volatility is not the cause but it is the manifestation of the problem.
The chart above captures the movement of the Nifty and the Volatility index since August 01st 2018. For easier comparison, both the numbers have been indexed to the base of 100. It is clear that as volatility has gone up from the third week of September, the Nifty has drifted down. Even over longer periods of time, the Nifty and the VIX are inversely related. The question is about your investment strategy. Let us look at the five things that you must avoid when you are in the midst of a volatile market. Here are 5 things to avoid:
1. Don’t rush for the exits the moment you see volatility
You don’t need to rush for the exits the moment you see volatility. Remember that volatility is part and parcel of the market. More often than not, the volatility is caused by external factors and the volatility will quell along with that trigger. For example, in the current situation, the market volatility has been caused by the rupee weakness and the IL&FS crisis. Both are temporary. It is not like 2008 where the Lehman crisis was raising questions about the entire financial sector in the world. When you exit in a hurry, you lose out the long term potential of a stock. The Nifty may be down since the peak but since the beginning of the year it is only marginally down. When the markets turn volatile, it is time to take stock of your portfolio and stick to the winners and dilute your holdings in the stocks that are most vulnerable. Don’t just convert everything into cash.
2. Don’t be too enthusiastic about bottom fishing in volatile markets
It is normal for investors to feel that when they were willing to buy Stock A at Rs 3000, why they must not buy the same stock at Rs 2000. While this is a quality company and you may be right, there is an important point to remember here. When the markets crack over 10% in a short span of time with a rise in volatility, the markets can never show a V-shaped recovery. The recovery will be gradual and calibrated over time. Typically, markets recover when the last weak hand is exasperated and exits the market. Also markets bottom out in the midst of disinterest and not in the midst of volatility. You will surely get better prices on most stocks. Be careful of how you bottom fish in such markets.
3. Your SIP commitments must not be tampered
If you are into a monthly systematic investment plan of an equity fund, just don’t worry about the volatility. The SIP is designed to benefit from the volatility because when NAV is up you get more value and when the NAV is down you get more units. This will benefit you both ways through the power of rupee cost averaging. Most equity SIPs have done very well over longer periods of time irrespective of the volatility. The long term SIP returns of equity funds are much better than the returns on lump sum investments because the phased approach captures the benefits of volatility better.
4. Don’t jump into sectors that caused the volatility in the first place
This is a very important take-away for the investor. Look at the sectors that drove bear markets in the past, like cement, technology, real estate, capital goods etc. They were never the stocks that triggered the recovery. For example, most real estate stocks are still quoting at a fraction of the price which they quoted in 2007 or early 2008. Let us look at the present scenario. The correction was triggered by problems in the NBFC space and the mid cap space. These companies were exposed to financial risk and had lower standards of corporate governance. They have longer term problems and are unlikely to lead the recovery. At best, they can experience a short-lived burst of upward movement in a largely downward trend.
5. Don’t stretch your luck too far with futures positions
When markets are volatile, the last thing that you should be doing is leveraging yourself. There are various types of leveraging you should avoid. Avoid borrowing and investing just because the markets are looking cheap. You could take a hit both ways. Secondly, avoid too much of short trading. Your stop losses will get triggered and you will end up in losses on most occasions. Thirdly, futures may look to be a very appealing method but here again you are leveraged. Losses could really multiply in a volatile market.
These are some of the basic things that you need to avoid when you are in the midst of volatile markets. Otherwise, don’t tinker with your long-term financial plans too much.