In a falling market should you cut your losses or dig in deeper?

Over the last year or so, almost every evening on my way back from office, I would meet Mr. Pathak sitting along with his group of friends under our building discussing the stock market. As I passed them, I would often hear them dole out tips and advice on what to buy and sell .

But since the last few weeks, the gang seems to have disbanded.

And it’s not just Mr. Pathak and his group of friends. As stock markets around the world crashed in recent weeks, leaving investors poorer by trillions of rupees, both investors and so-called ‘experts’ have been left dumb founded.

Everyone seems to know exactly what to do when markets are booming. But when markets fall , investors often indulge in panic selling, hiding out in cash, or end up trading frantically.

They make several mistakes that can hurt them in the long-term.

A lot of experts list things to be prepared for when the stock market crashes but what must investors do after it actually does? In a falling market, should you sit tight and do nothing, cut your losses or should you add more stocks? Read on to find out more…

Investment Time Horizon

Choosing the right stocks is no simple task. But the investment time horizon is equally important.

One of the biggest mistakes an investor can make is not aligning the timeline of their goals with their investment in stocks.

Before we talk about what an investor must do in a falling market, it’s of paramount importance that one understands the importance of the time horizon first.

Investment time horizon refers to the amount of time an investment will be held before the money is needed back. Time horizons can help decide the type of stocks you choose to invest in your portfolio.

As the time horizon gets longer, an investor can choose to increase the risk in his portfolio. If the stock market is falling like in the current scenario, a longer time horizon allows more time for the portfolio to recover.

Time horizons can be subjective as per investors needs and goals but we could classify them into three periods: short term, medium term, and long term.

Short-term horizon is anything less than three years. When markets crash, this timeframe could be too short for a portfolio exposed to high-risk stocks to recover.

Medium-term time frame is between three to seven years. With this time horizon, an investor can hold on to riskier stocks and allow one’s portfolio to grow without being overexposed to risk.

Long-term goals are generally more than seven years. Over such a long time period, an investor could stay invested in high growth stocks for a higher potential return.

Even in a sustained bear market, the investor would have enough time to weather the storm and hold on to his portfolio.

And just like all things related to the markets, time horizons are also dynamic and constantly changing.

An investors time horizon could shift with age, new goals or a change in financial situation, etc. It’s even possible to have multiple time horizons at the same time.It could be an investor saving for retirement while simultaneously saving to pay for his daughter’s college fees or to buy a second home.Hence, time horizon is the principal constituent on the basis of which one can determine whether to sell existing investments or add to the portfolio in a falling market. Cut Your Losses Short In a falling market, especially when the market is heading into a major correction, investors must remember the all-important rule: Cut Your Losses Short.No investor wants to sell for a loss. Accepting failure is painful and difficult. But to become a successful investor, you must set your ego aside, take a small loss and still be fit enough, both financially and mentally, to invest again.Cutting losses quickly prevents you from suffering a devastating fall that’s too steep to recover from.And it’s not just us saying it. Consider this…Assume you buy a stock at ₹100 and it drops 10% to ₹90 during a market fall. You quickly cut your loss and move on. Now to reclaim that loss, you need to make an 11.2% gain on your next purchase with your remaining capital, which shouldn’t be hard to do.But what if you didn’t sell? What if the market fall continues and your stock falls to ₹50?To recover a 50% loss requires a 100% gain. How many stocks do you think double in price?This doesn’t mean you should sell off all your investments when the market is falling. Such a […]

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