Panic selling happens when there is a wide-scale selling in an asset class, causing a sharp decline in prices. In equity markets, it starts with a steep correction in the stock prices which leads market participants to believe that further fall might happen. This fear triggers further sell-off as investors try to contain losses or protect profits which actually drives down prices even further.
Selling in reaction
The main problem with panic selling is that investors are selling in reaction to pure emotion and fear, rather than evaluating fundamentals. Almost every market crash is a result of panic selling. More often than not, at the exact time that investors choose to abandon a market in droves, the stock market bottoms out or is near a bottom. Reacting emotionally to sudden shifts in the market typically has negative consequences. Investors must hold their nerve because they “can’t avoid equities” if they want reasonable returns over the long term. They should structure their portfolio to capture the returns of a mixed set of asset classes which will deliver in all weathers. It is human nature to run for the hills in adverse circumstances, but such behaviour can be counterproductive.
When everyone expects continuing fall in prices, that’s usually about the time markets turn around. In a bear market, many so-called experts will start touting doom-and-gloom scenarios. Predicting market movements in general is very difficult for any person. So an investor needs to take in these doom-and-gloom scenarios with a pinch of salt.
On the contrary, just because something has dropped 50% does not mean it cannot drop another 25%. What a rational investor needs to do at this time is listen to the story of what the company’s operating performance and its business developments are trying to tell and not what the market makes of this story.
However, betting on a company just because it has depreciated severely would also not make much sense. Here the amount of due diligence and conviction required from the investor is even more. Many investors make this mistake of trying to catch a falling knife and get hurt in the process.
An investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behaviour from the super-contagious emotions that swirl about the marketplace. Not only is this detrimental to the long-term portfolio performance, it has also likely damaged the psychology of many investors who have later regretted their emotional reaction.
Throughout a bull market, there will be a number of sharp market declines where the selling reaches a feverish pace but each of these have been followed by further new highs.
Many investors who have sold in the moment and likely altered their long term plan did not get back into the market until stocks were much higher.
An investor needs to realise that the market value of his investments may be down today, but since he doesn’t need any of it for many years to come, that doesn’t matter. Long before the money is needed, it would have had a chance to start growing again.
If you are investing steadily for the long-term, then intermittent crashes help you make more money, not less. For the long-term investor, equity is not good despite the occasional crash. It’s good precisely because it crashes. Volatility is a blessing, only if one has the stomach to see it through.
The author is head, Retail Research, HDFC Securities