Investing in the stock market is known to provide some of the highest long-term returns and can earn investors a profit in manifolds over the years.
People invest in stocks to reach their financial goals and earn a profit on their savings. It is a way to make money work for you rather than you working for the money.
What is stock market volatility?
Investing in stocks is a risky business. While investors can earn a high return on shares, we cannot overlook the volatility that comes with it.
Volatility can be described as the continuous change in the prices of stocks over a short period of time. Here, the price of stocks can rise on a certain day and can fall the very next day. For example, you may have seen situations where Sensex may have fallen over 400 points in a day and recovered on the very next. This can be considered as volatility.
High volatility also increases the VIX ratio (Volatility Index) also known as the Fear Index. It measures the amount of fear in the market as a result of the volatility.
The fear caused by a volatile market makes investors react in many different ways. Some start to panic as their investments get riskier and try to sell & exit the market. On the other hand, there are contrarian investors, who prefer investing only in situations when others are selling. Anyways, as shares start to lose value, investors often make hasty decisions that can result in terrible outcomes.
6 things you should NOT do when the stock market is volatile!
Here are six things investors should not do when the stock market is volatile:
1. Don’t Panic!
The number one reaction investors have when there is volatility in the market is to panic and make speculations. It is important not to be influenced by fear and do something irrational. Investors can consider buying a stock at a lower price but should not panic-sell. Instead, they should use this period of volatility to evaluate the stocks in their portfolio.
There are often many reasons why a person invests in a particular stock in the first place. If the fundamental values of why you invested in the stock are clear, then you should remain invested. However, if you are not sure of a particular investment, meet with your financial planner to decide a course of action to exit the market.
Remember, volatility in the market is only short-term, don’t panic-sell if your long-term objectives of investing in the market haven’t changed.
2. Don’t buy JUST BECAUSE prices are low!
When there is volatility in the stock market it is not advisable to invest in the market just because prices are low. This is because there is no guarantee that a stock with a low price today will increase in value in the future. In fact, the price may go even lower and you could end up in a value trap. (Also read- What are value traps?)
You need to analyze the stock’s fundamentals and track record. Look into factors like revenue growth, profit margin, price to earnings, debt-to-equity ratio etc as well as its future potential. If the stock shows a history of riskiness and volatility it would be best not to invest in them. Don’t be a bottom fisher!
3. Don’t believe everything you see on the news!
A sudden ‘breaking news’ segment on the stock market can cause people to make investment decisions that can prove to be disastrous in the future. News reports are not always authentic and often mislead or misguide the investor which can affect the sustainability of a stock.
News reports about the volatility of stock markets are usually short-lived and stock prices will bounce back like a ping-pong ball before you know it. This short-term volatility is often due to a current event in the economy. Once the event has passed, your stock price should be back to normal. As a serious investor, be aware of ‘breaking news’ but don’t follow it blindly.
4. Don’t make decisions based on international markets!
During certain periods, there can be a correlation between local and international stock markets. For example, a change in the leadership of a country could affect numerous economies around the world. But statistically speaking, such a correlation does not exist most of the time.
Volatility in the stock market is a reflection of individual events in an economy or movements in the economic cycle. The stock prices are a result of the anatomy of the local economy. For example, the Dow Jones in the US is completely independent of the stock prices in NSE’s NIFTY. Hence, investors should not be influenced by volatility in international markets, there may be various factors that could affect these stock prices.
5. Don’t rush to invest in volatile sectors!
An important rule for investors is to study trends in the market before investing. If there are particular stocks that drive bear markets- avoid these.
A stock that has a financial risk and a low standard of corporate regulations often lead to long-term problems and has a low chance of recovering. These stocks will have short bursts of upward movements but will have a long-term downward trend.
Do a market analysis of the sector you are investing in, if the industry shows a history of high volatility- you should remain of cautious before you invest too much money into it.
6. Don’t put all your eggs in one basket- Diversify your portfolio!
One of the biggest mistakes an investor can make is not investing in a variety of stocks. If a certain industry shows potential for high returns, it is not a wise decision to invest all your money here. This is because if a certain economic event has a negative impact on the industry- it could result in a huge financial loss for the investor.
It is better to spread your risk and invest in different stocks that are stable, have a strong market presence and good growth potential. Here, even if you face volatility in one of your assets, you have a diverse portfolio of stocks to cover your losses.
An investor looking to reduce their risks and control losses should diversify their portfolio and not invest in too many volatile stocks. Greed can often take over fear and this can prove to be disastrous. Investors need to perform a thorough analysis of the stock market before picking stocks to invest in. If they do not have the bandwidth to do this, they can consult a financial advisor.
- Investing in Bad News: Is it Worth Being Contrarian?
- How to create your Stock Portfolio?
- How To Select A Stock To Invest In Indian Stock Market For Consistent Returns?
Follow the tips listed above to help you get through a period of high stock market volatility. While it is important to safeguard your portfolio from the effects of a volatile market, remember the biggest risk is not taking any risk at all.