A number of factors that are responsible for the market volatility. The key ones are:
*With the general elections due next year, there is uncertainty on the political front;
*The rupee, which is intrinsically linked to global currencies, has been impacted by significant fluctuations in global currencies and in global commodity prices;
*The US Fed is expected to taper down the quantitative easing (QE) programme which will significantly impact the global liquidity situation. There is also an issue with the US borrowing programme with the ruling and opposition parties in the US tussling about the need to borrow more. While this has been temporarily resolved with the opposition giving in to further borrowing till early next year, post this cutoff date, the issue will arise again leading to further volatility.
*The Indian economy is going through its own issues with rising inflation being a point of worry, a high CAD and falling GDP growth rate.
If volatility scares you away from the market, think again. Volatility is actually a good situation to take advantage of. Volatility tends to mis-price assets, providing attractive opportunities for an agile stock picker. There are two key aspects to stay focused on during such conditions: asset allocation and targets
Maintaining your asset allocation becomes a key trigger to play volatility. Lets say you are an aggressive investor with a debt-equity asset allocation of 20-80 i.e. 20% of your investments are in debt while 80% is in equity. Now when markets move up, simply sell equity and invest in debt to the extent of retaining your asset allocation and do the reverse during market downturns. This strategy uses the well-accepted investment philosophy: buy on bad news and sell on good news.
One of the most acceptable indicators to see if the overall market is over or under-priced is the PE multiple. Assuming that the Sensex has a five-year average PE multiple of 15 times and if the Sensex is now trading at 17 times, sell part of your equity holding and move proportionately into debt. Whenever this indicator falls below 15, do the reverse.
You can overcome or even take advantage of volatility by using pre-set entry and exit triggers for your investments. Here is an example to explain this. If you want to invest in Company A, set an entry price and an exit price. Make the investment once the stock reaches the entry price and exit once it reaches the exit price without waiting for a lower entry or a higher exit. Stay disciplined. This helps you avoid the two most common sentiments while investingfear and greed. This strategy helps you avoid timing the market. For example, assuming Comp- any A has traded in the range of R450 and R700 in the last one year, you can set an entry price at say R525 and an exit price at R650. Whenever the market or stock volatility brings the price of Company A near R525, buy it and exit at R650 without pondering over whether you will get a better price at either the entry or exit end.
Market volatility offers numerous opportunities to profit. However, one needs to be agile and flexible in order to benefit from volatility. Active market players such as mutual funds are equipped to use volatility to book gains. Use their expertise to make your gains.
The author is MD & CEO, Icici Prudential AMC