Don’t Catch the Falling Knife

When markets fall they fall by gravity. There is no level one can calculate as bottom. One needs to wait till the markets just fall and bottom out.

We cannot gauge to what level markets can fall. Once we know that the the stocks we own are much below our buying price we somehow try to cover those losses. These loss making positions can force you to be comfortable by buying low levels. But still the prices may fall and eventually these positions may block some more capital and still make losses.

How do we react to sudden fall in the stock we own do dearly?

Shock? Panic? Grief? And haste to cover losses?

Usually this is the process. Lot of pain and agitation takes place leaving you restless and then you plan for some quick fix and wait for time to come.

We have a classic example here. The name of the company is Silverline Technologies, It was booming in year 2000 dot com rally. From Rs 190 in yr 1999 it rallied upto Rs 1390 in Feb 2000. But with the IT dot com bubble bust it really tumbled down and was trading 1/3rd of the peak just after two months. It never recovered to that level too as it fell further to 190 an year later. It was there till the trading was suspended on the exchanges at Rs 2 which is actually zero as you cannot sell anything now. There are many investors stuck into it without any hope. Same story is repeated for Indage Vintners (Formerly known as Champagne India) which was trading at 700 levels in 2006 -7 and just fell to Rs 13 levels.

We also have recent examples of Educomp, Core Education, Suzlon, Unitech, FT, Gitanjali and so on.

It does not matter whether market is trending up or down. When the fundamentals deteriorate then nobody can save the price. It is better to get out before it becomes impossible to exit. There is so much emotional and financial destruction when such trade occurs. You need to accept the mistake and bow down and just exit with whatever is left.
At any point you try to average here is like writing off more capital for a rigged stock. Just look at the balance sheet and you will get an idea.
Simple question to be asked for yourself is
What are growth prospects?
What are the peers doing?
Where is the real damage? Is it sentiment or performance?
What about the cash in the balance sheet?
Last one would be would you buy it fresh if not held earlier, after considering the fundamentals?
Averaging is very tempting when you look at the market performance but it should not be induced out of losses or as a reaction to prove something.
Lets discuss another situation not so severe.

When the markets fall, they fall by gravity.
Stock market crash does not spare any stock from leaving the top room. They all fall with different slope. Some are leaders and others are laggards. Market correction is not 1 day phenomenon, it is a process and you get certain indications also, but are mostly ignored because of many reasons we discussed in the previous articles.

While the rally is in place, entry and exit does not matter and profits keep flowing in. At the time of distribution when excessive demand is in place, it often happens that investor confidence is also at its peak. Investors tend to go in for positional gains which are quite huge in nature. At the time of 2007 -8 market euphoria, Stocks like HDIL rallied from 400 to 900 within just couple of months and it is very lucrative time. Investor tends to cross this thin line of investments and speculation and he sees the money too. It often results into putting high money at stake. If it is near term requirement then the position is very risky bet limits are stretched in hope.

A person who is comfortable with 2 Lac in equity may put 10 Lac, being very confident of making it double in few months. I know a person who could buy a Santro for 4.5 Lac bought shares of that amount to buy a Scorpio if he could wait for couple of months. Unfortunately he took that decision in Dec 2007.

So the point is, with so much optimism in crowd, when things dont fall in place then the panic starts penetrating in the crowd. Fear of losing all the hard earned money, fear of defeat, fear of admission of losses just plays the right part of huge sell off.
Then the obvious phase of reactions arrives. Just by hook or crook you want to at least make even. The speed and volatility is so much everyday that again you are certain of using your stock market knowledge and use both sides of movements to make some money.

The correction period is only action and offers no time to think.
So at any point of time you may feel that this is it. Now is the full stop for the fall. But to your surprise it extends beyond that support level you have in the mind. And you are again compelled to take some quick action to resist your losses.

Here again the prices look very attractive as compared to your initial buy. For an example when markets crashed Tata Steel was trading around Rs 970 and when it halved many value investors thought it was a dream price as that was the stock price during Corus buy and it never saw that price again till it fell to that level in 2008. So temporarily it was there for quite some time to fall to Rs 140 levels in Oct 2008 and again in March 2009.

Here if you have bought Tata Steel at Rs 900 and again at 450 levels to average down your buying cost will be at Rs 675.

So when it falls to Rs 150 or Rs 140 it is again a disaster and actually that is the tome when you should be buying stocks for long term investments.

Value picks run at a lot of discounts after the disastrous fall in the markets. But you will be able to pick only if you have some cash left in your hands and some confidence off course.

To conclude the Tata Steel example. This stock after 5 years also has not reached the level of Rs 675 and the markets are at record high levels surpassing the top in year 2008.

So many opportunities it presented to the investors during these 5 to 6 years. Many investments held from 2008 are also profitable. But if you really analyze the volumes and retail investors participation, it is way below as compared to 2008 rally.

Trying to catch the falling knife during the crash might really have taken a toll in the investors and traders. It does hurt with a bump in cash and rising inflation has added to the worries. This phenomenon is classic though and true for all the markets and all the countries and cultures throughout the entire globe.

It is very important to let the fall settle. Bottom is not formed in 1 day or a week or month. It takes many months to form a solid bottom and create support at certain level.

Market crash is triggered by fear and panic and it is very intense. But it takes a lot to reverse the situation. It is wise to observe the market carefully with all the economical indicators. It is only that distressed situation which will present you with a lot of value opportunities. This is the time when you can buy and keep the stocks and enjoy dividends your entire life.

All it takes is to have cash in your pockets and a lot of common sense and basic knowledge to understand fundamentals.