Let’s refresh our memory with a list of things an investor should not do during a correction, so as not to harm his financial and moral state. The rally in world markets has been replaced by a correction, which looks menacingly at investors from the chart of the U.S. S&P 500 Index. In the 18 months of nearly uninterrupted growth since April 2020, seasoned investors have become accustomed to deep drawdowns, and newly arrived private investors risk encountering it for the first time. Here are 5 things not to do.
Panic and urgently, “do something about it.”
During times of high volatility, it can feel urgent to do something about it. Especially when the value of the portfolio is declining. However, this more often than not leads to rash decisions and commission costs rather than benefits or risk mitigation.
A correction is a reason to think hard. It’s worth assessing what caused it, whether something has changed in the business of the companies in your portfolio, and examining your emotional reactions to market fluctuations.
It can be useful to remember your investment objectives and assess how they overlap with the observed correction. Only after that can you make any adjustments to your portfolio.
Sell the best securities in the portfolio
In a fall, there may be a desire to lock in profits on those securities that have risen the most. The logic is simple and straightforward – the more it rose, the harder it can fall, which means you have to take your profits and run. But often, in practice, this is not the case.
A strong rise in securities is almost always associated with strong fundamental drivers. If these drivers remain in place during a correction, then such stock may, on the contrary, be much stronger than the market and recover faster than others. By excluding it from the portfolio, the investor risks losing a promising asset.
Buying what has fallen the most
The other extreme is to buy back the worst-performing assets in the expectation that their potential for recovery is higher. That potential might not materialize. Before you buy something, you should find out why this particular stock has fallen so much. Maybe the risks to it have grown too much, or maybe the growth in the previous period was not justified, and the correction only brought things back to normal. In these cases, you should not count on a quick recovery.
Speculate with leverage
The temptation to buy a falling stock with leverage and make a quick profit on the rebound can lead to unfortunate consequences. The drawdown may be deeper than it appears, leading to forced closing of margin positions with losses in the worst-case scenario.
Capturing a loss at the peak of the panic
When a stock falls, investors often keep their eyes on the quotes and make their decision to sell based not on analysis, but on how close the size of the loss is to their psychological pain threshold. In this case, the decision to sell the falling securities comes spontaneously. It often catches the investor at the peak of market panic, when the securities are trading at the lowest point of correction at high rates.
If you are confident that the stocks in your portfolio remain promising, avoid checking your balance every minute and devote that time to more pressing matters. This will keep your nervous system calm and your mind sober.