The legendary investor Warren Buffet once said “Be fearful when others are greedy, but be greedy when others are fearful”
Stock market corrections oftentimes are scary but it’s always been the part of the game. This is a sign of a healthy market. The stock market correction or sometimes a mini-crash is usually a drop in stock prices 10% or more from its recent peak. The recent stock market correction might have panicked and reminded you of the Black Day we observed way back in 2008.
If you were a trader or investor at that time, you might have experienced the avalanche of pain that dwindled you financially. The stock market is controlled by notorious Greed and Fear. Once the Fear grips the market, then Stock Market Crash is likely to happen where more than 20% or 30% can’t be ruled out.
Some market predictors, noted economists and veteran investors claim to have noticed that 70% stock market correction happens during November. If you search for stock market history, you’ll see that the October is a month where strong sell-off panics the global stock market and the crisis ultimately paralyze the sentiment of investors.
Why Stock Market Correction Happens Frequently?
Because the market had been performing so well, and many investors were afforded to invest more money in it. These people were investing in speculation. This means that they were buying stocks with the intention of selling them in the future for a higher profit. Even some of them don’t hesitate to invest money they borrowed from banks. And when prices start to drop, people realized they would not be able to pay off their debt. They rushed to get out as soon as possible.
Ever since the stock market bottomed out in March 2009, the broad-based S&P 500, led by some tech stocks and other growth stocks, had surged by more than incredible 325%! But have you ever thought while the stock market has historically returned 7% a year, how this could be possible? Indian major Index Nifty 50 also gained massively approx 300% The insider fact is that the bull market won’t last forever.
Stock market corrections are a healthy and normal part of the investing process. Eventually, we may see another stock market crash. The only question left to be answered is what will cause it. Is the stock market correction a beginning of a major sell-off or a crash?
Professor Didier Sornette, at the Swiss Federal Institute of Technology, argued that a stock market correction or crash is not simply a normal down day but a true outlier to market behavior. His works aimed at interpreting clues and identifies symptoms of formation of a bubble and when it ends. He made the interesting observation that bubbles do not necessarily form in steady in bull markets. For a bubble to form, price gains have to accelerate at a “super-exponential” rate. It is well documented that prices tend to go up faster before a crash.
Ever since 1900, S&P 500 had eventually recovered fully in value all its dirty stock market correction or crash within a year or two. Keeping this in mind, if you dare to stay invested, and then recouping your loss because of correction is a matter of a few quarters time frame. What you need to have are self-confidence and patience. Market behaves similarly like climbing the hill. Have you ever noticed how the Mountaineers climb a peak? They first climb higher and then step down the hill and stays at base camp at a lower elevation.
Market experts believe that certain factors such as 1.Fear that the Fed will raise interest rates drastically that may hamper investor’s sentiment negatively; 2.Worry from tech companies (chiefly shares FAANG-Facebook, Apple, Amazon, Netflix and Google) that tariffs on Chinese imports will drive costs higher; 3. The upcoming earnings season as expectations fall for corporate profits contributed to the down-drift; 4. Turmoil and fluctuation found in the crude oil market; 5. A global trade war erupts; 6. European Crisis in the banking system similar to Lehman Brothers is somewhat concerning.
Dealing with Stock Market Corrections:
A correction is an inevitable healthy process, simply the flip side of a rally. You can’t escape this because market behaves and moves this way always. Fundamentally, or even technically corrections adjust equity prices to their actual fair value. In reality, prices go down because of speculator’s reactions to the expectations of news or actual news, and investor profit taking.
Here’s a list of twelve precautions you need to consider during stock market correction of any magnitude:
- Your current asset allocation should have been tuned into keeping your long-term goals and objectives. You should resist your urge to be the part of a panic selling at a sizable loss. And waiting too much to expect the prices to correct further in their stock prices, can be a lost opportunity. Fundamentally good stocks seldom give you many opportunities to get into them.
- Take a look at the past. There had always been a correction that had proven to be a good buying opportunity. Start figuring out the performing sectors. Make a list of high quality, dividend-paying companies and prepare to buy them at every dip at their strong support levels (weekly) or Fibonacci levels. And wait and watch for the stocks to bounce back from those strong support levels. Make sure that the stocks confirmed reversals. Believe me, this is one of the safest ways to stay invested in. They can be rewarded you handsomely for the risks you have taken. You don’t have to worry much whether the market falls or rises as speculated. What you need to do is to divide your investment fund into many sizable parts and wait for the desired level of correction. This may be a percentage-wise (Fibonacci percentage) or an important support level on the daily or weekly price chart (say 200 SMA). And after the end of much-awaited consolidation, start investing slowly in your selected stocks when the market is reversing and about to take off.
- Take a look at the future. You never know when the rally will come to an end or how long it will last. If you dare to buy quality stocks at their fair value, you will be able to ripe the benefits when the market starts rallying again driven by positive sentiments. Believe me, this is the way market runs. If you really want to survive in your investing business, you need to keep contrarian view about the market when majority investors stay away from it.
- Try to stay with the quality large or mid-cap Indexed stocks or blue-chip stocks in your long-term investment portfolios. If you go with high-quality stocks, chances are high that you will recoup your losses within a short period of time. This is because when the market reverses its direction, these are the stocks that will bounce back first and rallied to produce maximum gains.
- Identify new buying opportunities using a consistent set of rules during rally or correction. Focus on good quality under-value stocks for your next buying for being less risky, and better for your peace of mind. Just think where you would be today had you heeded this advice years ago.
- If you worry too much about your invested stocks, then stop watching the stock ticker frequently and focus on the fundamentals of the company instead. Analyze Price Ratios like I) Price-to Earning (P/E) Ratio, Price-to-Sales Ratio, Price-to-Book (P/B) Ratio, Dividend Yield etc; II) Profitability Ratios: Return on Asset (ROA), Return on Equity (ROE); III). Liquidity Ratios-Current Ratio, Quick Ratio, Cash Ratio; IV) Debt Ratios: Debt-to-Equity Ratio, Interest Coverage Ratio; and V) Efficiency Ratios such as Asset Turnover Ratio, Inventory Turnover Ratio. After proper analyzing, get rid of fundamentally weak stocks during their bull rally.
- If you are really interested in buying value stocks, be selective to choose the sectors that are currently performing best where FIIs (Foreign Institutional Investors), Hedge Funds are putting their money in. FIIs, Hedge Funds are always looking out for the markets with the cheapest valuation and move on with their myriad investment money. If you are able to go with them, then you can literally print your money in the stock market. FIIs, Hedge Funds hardly lose money in the stock market.
- When the market or major indexes of your country are incredibly sky-rocketing higher and higher with new highs, you should be skeptical and analyze their P/E Ratios, and other technical indicators like Divergence or ROC (Rate of Change). You should be very careful about the market especially with higher P/E ratio and when prices are racing higher, but ROC indicator is sloping downward.
Next time, when the markets are racing higher, and you feel like you won the lottery, consider this bit of biblical advice. The old joke goes, when did Noah build his ark? The answer, of course, is: Before it began to rain.
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