There is a simple analogy behind the question. If you Panic while there’s a correction in the stock markets, either you are not diversified or you are too aggressively invested in the stock markets. Let’s learn further if you should panic in the recent market crash and how can you protect your capital from such downsides.
What is a market correction?
Before we get to answering the question, let’s identify what are market corrections and why do they occur.
A simple decline in the benchmark indices like Nifty50 or SENSEX is commonly known as a correction. Corrections are extremely common in the stock market and generally, there is no reason to panic if one comes by.
However, some corrections are slightly deeper and last typically longer. These can be dangerous as some of the stocks tend to fall as much as 40 to 50% during such times.
Let’s know the different kinds of market corrections and the difference between a correction and a crash.
1. Correction (10 to 18%)
Corrections are a common phenomenon in every stock market. Minor corrections are considered important as well as healthy during a bull market. Small declines of 5-8% are not considered as corrections but whenever the market falls more than 10% from its recent peak, that is known as a correction. Regular corrections can be led by normal profit-booking from investors and institutions or any other reasons. Such corrections are typically short and the market bounces back swiftly thereafter.
2. Crash (More than 20% in a short time span)
A crash is a scenario when a particular index or stock dips by more than 20% pretty quickly. Crashes are rare and can take place within days or weeks. A stock market crash is not very common as one comes by every 5 to 10 years. The latest crash that we witnessed was in 2019 due to the Covid-19 pandemic. Crashes can be scary as investors’ portfolios bleed a lot during this period. A stock market crash can be an excellent time to accumulate good quality stocks and downward average your holdings.
3. Bear Market (<20% for a prolonged duration)
A Bear Market represents a phase in the markets when a particular index or asset falls by more than 20% from its recent peak and continues to trade lower for a substantial about of time. Bear markets are longer than corrections and typically last between 12 to 16 months or longer. A bear market is mostly caused by adverse economic conditions or a recession that is reflected by individual companies. There have been only 26 bear markets in the US since 1928. On the other hand, the Indian markets have only witnessed 4 major bear markets in the last 25 years. Out of which the previous bear market was witnessed in 2020.
These were the three phases of a correction. Investors often mistake a dip of 2-4% as a correction but until the underlying falls by more than 10% it is not considered as a correction.
Similarly, many investors panic when markets fall by 10 to 15% but is that right? Let’s find out whether you should panic when there is a fall in the markets.
Should you panic in a market fall?
The short answer is No!. You should not panic when there is a correction in the market if you’re holding fundamentally strong stocks.
However, the long understanding varies from the short answer. Recently global indices including the Nifty50 index have been scaling new lifetime highs without a reasonable pullback. This has caused investors to believe that markets always go up in a similar fashion.
On the flip side, when the markets made a healthy correction of 10-11% in November 2021, new investors misread it as another stock market crash.
Therefore, it is imminent for new investors to panic in such an unforeseen scenario. But in reality, this is a normal occurrence and you should not panic and start selling in such a condition.
In addition to that, corrections are a great time to purchase more stocks at a discounted price. If you are a long-term investor, this might be the best time to include good stocks in your portfolio. So that once the market shakes off this fall, your investments will reap benefits and you will be able to grow your wealth much faster.
How to protect your Portfolio during a fall?
The best way to stay unaffected from any market corrections is to diversify. By spreading your assets into different asset classes such as stocks, bonds, commodities, etc, you will not only spread your risk but equally preserve your overall capital. By following a safe asset allocation ratio as per your risk profile, your capital will not be affected much even if one of the asset classes performs poorly. Moreover, it is important to re-balance your portfolio periodically to maintain a healthy ratio between equity and debt. By undertaking this, you will be able to ride the ups and downs of the market safely.
Besides diversifying, you can also actively apply hedges to your portfolio with the help of options and futures. So that even if your portfolio goes down, the gains made from your positions will offset the loss.
Before investing in capital markets, you should evaluate your risk profile and decide your asset allocation accordingly. With this, you will be capable to take calculated positions and also manage your portfolio efficiently. Having some surplus cash on the sidelines at all times will be an added bonus because if there’s any small or major correction. You can then deploy that money and average down your investments.
Hence looking at the long-term view, you should not panic if the markets fall slightly. Rather you should view these corrections as golden opportunities to buy more at a lower price.