Remember, the price of a stock is always justified by the underlying value of a company.
To a novice, the stock market might seem like a place where one can easily make quick bucks but this is seldom true. Stocks are governed by complex variables, and it takes time to understand market fundamentals.
As an investor, you should keep in mind that first, you need to have a robust understanding of how the market functions. Then comes assessing your investment horizon—be it short-term or long-term. You must also keep in mind your individual risk appetite, or the amount of money that you can afford to lose while still remaining up float. At this juncture, it becomes imperative to underline that in stock markets, winning and losing, or rather making profits and incurring losses in investments, are two sides of the same coin.
Worried about tackling the emotional upheavals of the stock market? Here are three tips to help you manage your emotions during turbulent market phases:
1. Understand that loss is unavoidable
Before beginning your investment journey, you must understand that loss is unavoidable in the stock markets. Even seasoned and famous investors have incurred huge losses at some point in their lives but despite the setbacks, they maintained their composure and refused to quit. Ultimately, they bounced back with aplomb.
As an investor, another key factor you must consider is though losses are inevitable, the risk can be minimised by making prudent investment decisions. This means investing your hard-earned money in a diversified portfolio of companies. And, you should always zero in on the companies that provide and exhibit verifiable potential for growth. Having a diversified portfolio of stocks will ensure that even if a portion of your preferred stocks fails to live up to the expectations, or perform miserably, you still have the remaining portion to compensate for the losses.
In other words, while creating your investment portfolio, you should always keep in mind the risk to reward ratio. You should also have a sound capital management strategy. Protecting your capital, in the long run, will help you minimise losses. To conclude, though profit and loss are part of the game, you can still minimise risks by being judicious.
2. Don't get caught in the stock market bubble
Another tip to manage the emotional upheavals of the stock market is not to get caught in a stock market bubble—characterised by the market getting irrationally optimistic. In the case of a stock market bubble, people start believing the performance of stocks will only get better. Typically, a stock market bubble is represented by a cycle where there is an accelerated expansion only to be replaced by contraction. In a stock market bubble, there is frenzied buying by investors.
When a large majority of the investors start buying—with the sole motive of making quick profits—stocks become scarce. This results in a scenario where the prices of stocks skyrocket. Remember, the rapid rise in the price is without a corresponding increase in the company’s underlying value. After some time, investors start realising that the rise in the price is without a viable reason and they start selling off the stocks. The herd mentality—a key characteristic of a stock market bubble—again follows and investors quickly start selling their stocks.
But, now the market starts dipping and several investors suffer considerable losses. As the market begins to correct itself, the bubble gets punctured or bursts. A stock market bubble burst can result in market devaluation or even a market crash. While investors face colossal losses, the market recovery rate is painstakingly slow. Thus, as an investor, you must guard against bubbles, and maintain your rational calm.
3. Trade on fundamentals
Though stock prices can change overnight, a company’s fundamentals don't. Investing in fundamentally strong companies in the long run can help you take emotions out of the game. You must conduct a comprehensive market research to know about a company's strength.
The key parameters to consider before investing in any company's stocks include market capitalisation, growth in income, net income, debt to equity ratio, price to earnings ratio, issuance of dividends, stock splits, mergers and acquisitions and so on. Remember, the price of a stock is always justified by the underlying value of a company. Though a company with strong fundamentals can be impacted by stock market upheavals, it will eventually recover its strength and position.
Conclusion: Thus, maintaining your emotional composure is an absolute must during stock market upheavals. These tips can help you stay calm during challenging times in stock markets.
(Prabhakar Tiwari, CMO at Angel Broking.)Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.