Friday, November 11, 2016

Stock prices are fluctuating wildly - what should small investors do?

To answer that question, one needs to understand why stock prices fluctuate. You can read this article to learn more. 

In an ideal world, a stock's price moves only in one direction. If it is moving up, you make money by 'buying low and then selling high'. If it is moving down, you make money by 'selling high and then buying low'.

But life, and stock markets, are never that simple. In a longer-term up trend, there are periods of correction and consolidation that provide opportunities to buy for experienced investors.

A longer-term down trend has periods when there are counter-trend rallies and consolidations that provide selling opportunities.

If you prefer to look at stock price movements through a filter of fundamental analysis, you look at valuations and ratios. If you rely on technical analysis, you look at trend lines and chart patterns.

But there are times when markets seem to go completely haywire. Valuations go out the window in a frenzy of buying. Technical patterns and support levels lose all meaning amid a wave of selling.

Much like what has been going on for the past couple of days. Why? Primarily due to a couple of reasons that Taleb would call 'black swans' - events for which there were little advance warning and which are likely to cause upheavals in the economy and the stock market.

To make matters worse, these two 'black swan' events - Trump's victory in the US Presidential elections and demonetisation of Rs 500 and Rs 1000 bank notes in India - coincidentally occurred on the same day, viz. 9/11!

The best thing for a small investor to do is not to panic. 'This too shall pass'. 

If you have proper financial and asset allocation plans in place, you should simply follow those plans and invest accordingly.

If you don't have plans in place, the stock market will seem like a casino and you are unlikely to realise any of your your financial and investment goals.

If you are itching to fish in troubled waters, remember that you have to know exactly when to enter, how long to stay and when to exit. That is difficult for even experienced investors.

2 comments:

Eswar Santhosh said...

While I agree that Modi's announcement was a black swan, Trump's win is not exactly black swan. The probability of Trump winning was always there (I bought Nifty Puts). The consensus was wrong just like it was about Brexit. But I think, a low probability event, which was thought impossible due to the media, may not necessarily qualify as a Black Swan event.

Subhankar said...

You are quite right, Eswar. Trump's victory was unexpected but not a 'random' event.