Indian equity markets have slumped over the past few months due to several concerns- high inflation across the world, global central banks (including Reserve Bank of India) raising interest rates, war between Russia and Ukraine, high crude oil prices, lockdown Due to rising COVID cases in China, global supply chain constraints and huge Foreign Institutional Investor (FII) fund outflows from Indian equities, etc.
Given the recent fall in the markets and the many uncertainties, it is natural for many of us to extrapolate the current situation, and worry that the downtrend may continue. There is a strong natural temptation to exit the equity now with the intention of entering back at lower levels later. While this approach sounds logical, unfortunately, there are some counter-intuitive patterns (read traps) that occur in downtrends that make it extremely difficult to re-enter the markets once you have sold out.
Here are five counter-intuitive patterns to look for.
Pattern 1: Recovery in the equity market usually happens in the midst of bad news.
It is difficult to time your entry back because history shows us that the stock markets usually hit their lows before the worst news hits. The recent Covid 2020 crash was a classic case, where the Indian markets surged 40% before peaking in the first wave of actual COVID cases. This is a pattern that is seen in most bear market recoveries, both in India and around the world.
Pattern 2: There are many false reversals in a market downtrend and many false reversals in the actual recovery.
Many false reversals occur in the midst of market downturns. Once you experience several false upside rallies in the midst of a market downturn and continually add bad news to it, there is a high chance that you can dismiss the actual recovery as another false upside rally. Huh. To make things more confusing, even the actual recovery has a lot of false intermittent falls. As a result, it is very difficult to differentiate between a real recovery and a false upside rally.
Pattern 3: Recovery is usually very rapid.
Waiting a few months (eg, about six months) for a confirmation of recovery (versus a false upside) also doesn’t work well, as most of the time, the initial recovery rally is extremely rapid. Take this example: The Sensex rose 85 per cent in just three months during the 2009 recovery.
Pattern 4: We become attached to the lower levels psychologically.
Once you miss the lows of the market, you are usually psychologically driven to the lower levels and it is practically challenging to enter back to the higher levels.
Pattern 5: No one can predict the market in the short term.
Even the best market experts cannot accurately predict the timing of market corrections on a consistent basis. There are many emerging factors that affect the markets in the short term and it is difficult to predict how millions of investors are going to react to that. If you are planning on waiting for your favorite market expert to tell you when to enter back, it may not be a good idea.
Overall, while exits are easy, these five counter-intuitive patterns coupled with the fact that short-term market movements are difficult to predict can make it extremely difficult to time your entry back if you exit now. Is. A temporary drop, while undoubtedly painful, is the emotional fee equity investors have to pay for better long-term returns. As we mature, our approach to market downturns becomes one of acceptance rather than denial.
The best course of action would be to stick to your asset allocation between your basic plan i.e. Equity, Debt and Gold. If the market continues to decline, maintain a balance back to your original asset allocation (ie, increase equity and decrease debt/gold) at regular predetermined intervals.
The boring but proven mindset required for successful investing remains the same – be patient (stay at least 7 years on time horizon), be humble (try not to time the market), be prepared (be prepared for temporary market downturns). To endure) and remain optimistic for a long time (belief in human ingenuity).
Arun Kumar is Head of Research at FundsIndia.