Dealing with market corrections – what you should and shouldn’t do

A stock market correction should be welcome by astute investors because it provides immense stock picking opportunities. Let’s take a look at the do’s and don’ts when everyday brings out a new low and the going gets tough!

A correction is nothing but an adjustment of the prices so that they reach their “support” levels. There are various reasons why prices may go down even though the fundamentals of the scrip may be intact. News of adverse events, perceived threats to the prospects of the stock, profit-taking by large institutions and even a fire-sale like that of Bear Sterns can lead to corrections. You must remember that these are a normal part of the market cycle and only those that learn how to tame these cycles can emerge winners.

Things you should keep in mind during a correction

No emotions please: The first thing to remember is that no decision should be taken in a rush of emotion. When stock prices are falling uncontrollably, it is easy to get trapped in a vicious emotional cycle. The fear of losing money is so overpowering that one may take hasty decisions that can lead to heavy losses.

Step back, take a deep breath and review your portfolio: Look at the stocks that you have and the sectors that they belong to. What are their individual performances? Are all the sectors and all the shares equally hit or are there pockets that have been spared the paring. Are you overweight in any sector? Do you have a diversified portfolio? Take a hard look at the portfolio and ask yourself the questions that you might have otherwise not cared for.

Diversify and diversify: Market mayhem really brings out the advantages of diversification. If you had banks and infotech stocks in your portfolio, you would have immediately seen the benefits of diversification. While banks have met the full blast of the correction thanks to the inflation and the feared interest-rate hike, infotech stocks have been riding the crest of the wave thanks to the favourable trend in the rupee. So, make sure your portfolio has a piece of each sector: Pharma (Ankur Drugs), Banks (ICICI, Bank of India), Logistics (Sical, Concor), Capital Goods (Alfa Lavel, Thermax, Punj Lloyd) etc so that a downtrend in one sector does not catch you on the wrong foot.

Asset allocation: Your asset-allocation formula should be governed by your long-term game plan of life and not by the short-term gyrations of the market. Resist the urge to get out of equities only because you have been spooked by the drastic fall in prices. Instead if you do a dispassionate analysis of your situation in life and realize that equities are the asset class in which you should be overweight, by all means take advantage of the steep fall in quality stocks to beef up your portfolio.

No better time to stock up on the blue chips: Every sector has a top-notch performer that must have a place in your portfolio (see our top ten picks). This is a god-sent opportunity to hoard these stocks. If you have a long-term outlook (two – three years) you will be astonished at the returns you will get out of these stalwarts.

Don’t wait for Godot: Searching for the bottom to start investing? Well you’ll never find it because it will come and go without your ever realizing it. So, stop waiting. Instead adopt the time-tested formula of cost-averaging. What this means is simply this: First identify the corpus of funds that you have. Then make a shopping list of the stocks that you want to have. Don’t rush it but don’t dither either. Once you have made up your mind of the stocks that you want, use the market volatility to you advantage. At every dip in the prices, buy a little. Ignore the rallies – there is nothing interesting there. Welcome the sell-offs – that’s when you can go bargain-hunting.

Average your purchases: If you already hold blue chips in your portfolio, this is an ideal opportunity to average their cost.

Keep your eyes and ears open for new opportunities: Don’t get carried away by the prophesies of the pundits. However, don’t shut them out either. When you get a tip that a particular stock is a good buy, don’t rush in to buy. Instead, do your research into the fundamentals. It is not enough to ask “Is it good?” Instead ask “Is there anything better?” Make sure that the shares you buy are of fundamentally strong companies that will provide value in the years to come. Avoid fly-by-night companies with unproven managements even though the temptations may be irresistible.

Understand why corrections take place:

One of the reasons for the paranoia is the fear of the unknown – one doesn’t know what caused the correction and one fears that it will last forever. Everything has a reason and a rationale. It is important to come to grips with the situation and to realize that every correction has a limited time-phase. If you are a long-term investor, you will realize that after every correction, there is always an uptrend. And if you have bought quality scrips, they are the first to rebound after every correction.

This is as a good time as any to study our recommendations to add to your portfolio. Click here for our list of top ten shares that you must add to your portfolio.