Prepare for Stock Market Volatility and Profit from it
Stock market, by nature, is volatile. Sometimes volatility becomes excessive as in recent months. When positive and negative forces emerge in quick succession, market oscillates between optimism and pessimism, favouring bulls and bears in alternative bouts of buying and selling. This kind of oscillation swings the short-term trading strategy from ‘buy on dips’ to ‘sell on rallies’ and back again. This can be profitable/painful for traders, depending on the success of their trading strategies. But, for investors, this excessive volatility can be a good opportunity.
Often, the market overreacts: both to good news and bad news. Over reaction to bad news can be a great opportunity to buy. In fact, buying on bad news when the market has overreacted to it is a foolproof investment strategy, provided the stock selected for investment is a quality stock undergoing a temporary dip. For instance, in July 2012, when trouble broke out in Maruti’s Manesar plant resulting in the killing of a company executive, injuring many officials and shutting down of the plant, the market overreacted to the news and the bears hammered the stock to less than Rs. 1000. This proved to be a great opportunity for long-term investors who accumulated the stock at bargain prices and made a fortune when things came back to normalcy. There are many examples like this when buying on bad news became a very successful investment strategy. It is important to remember that this strategy will be effective in the case of large-cap blue chips; but when applied in mid-and small-caps, the strategy can be highly risky.
Buy on bad news strategy becomes simple (in retrospect) during sharp market crashes when blue chips become cheap due to widespread market pessimism. This happened during the market crashes of 1992, 2000, 2008 and 2013 when valuations became compelling. During such market crashes, stock selection becomes easy. But the investor needs the courage to buy, the stomach to suffer some more pain during the downturn and more importantly, the patience to hold.
At present, the market is going though a volatile phase, and this presents opportunities to buy on dips. But it is important to appreciate the fact that even after the correction, the market is not cheap. But on a bad day, reacting to bad news, the market will overact making the price of certain stocks attractive to investors.
Headwinds from political uncertainty and tailwinds from crude and improving micros are likely to set the market on a roller coaster ride in the coming months. The dips in this ride would be great opportunities to invest. A bottom-up approach to accumulate good quality stocks would be the ideal investment strategy in these volatile times. Risk-averse investors should stick to large-caps. Investors with higher risk appetite can pick good quality mid-caps beaten down in the recent carnage in this segment. Retail investors, particularly first-time investors who started investing say, 12 to 18 months back, are a bit unnerved by the negative returns on their investments. They should keep their cool. Negative returns would turn to very good positive returns when the tide inevitably turns. Continue with SIPs and, if possible, scale up SIPs.
(The author is Investment Strategist, Geojit Financial Services)