A successful self trader – Rule # 37
This is, probably, the one feature that separates success from failure in investment. Why is it so critical not to panic in the market? Simple! When you panic, you subsidize the other man who does not panic since returns on an investment are a given, the profits flow to the person who keeps a cool head while losses are borne by the person who panics. This is true of all investment products.
Why panic is anathema for traders
What is that one factor or attribute that differentiates an ordinary investor from a successful investor? Answer: the ability to not panic in a crisis. In this rule, we come to one of the most basic psychological trait that differentiates a successful investor viz. Panic. You will see this all around you. The investor who panics is a sure shot loser in the market. But why does this happen?
There are two aspects to panic. The first is the ability to let your head rule your heart in a crisis. Let us talk of a stock like infosys, which has seen a slowdown and a series of senior management exits. Has the management lost the plot? Look at the history. For 20 years it has bounced back from every crisis. Don’t panic. Great companies go through a process of reinvention and rediscovery. They rarely go out of circulation. Don’t panic. Just stay invested.
The second aspect is of leveraging panic. Quite difficult, but that is where investors can make money. Look at any panic bottom be it 2001, 2004, 2006 or 2009. Your risk-return trade-off is most positive when the panic in the market is at its peak. This is not the time to panic, but to beat the panic. Sounds hard, but big money never goes to elementary solutions.
The 3 golden rules of panic in markets
Panic is not the third option
If your stop loss is hit, just cut your position. If you are convinced of the stock, don’t hurry till your next rule triggers. Avoid the herd mentality. Panic cannot be an option. You either stay or move out. Ponder no further.
Nobody profited in a herd
Have you seen an investor profiting from a herd mentality. When the entire market panics consult your rule book and buy. Nobody lost money buying at a bargain sale. When the herd panics, that is your golden opportunity.
Don’t be a sucker for the penny stock syndrome
A panic is the time to buy value and quality, not to bargain for penny stocks. Cheap crap is crap anyway. Kingfisher and deccan chronicle are fundamentally flawed stocks. Even at peak of panic, they were worthless!
“when generals don’t panic, the troops never panic and that is when wars are won” – Shaquille o’ neal
5 cases when panic could kill the golden goose
- Positive panic (frenzy) was obvious in 1999 at the peak of the technology boom. Retail investors did not want to miss the bus. Buying in stocks like infy and wipro happened at over 100 times valuations. When technology stocks crashed in 2000, investors waited over 10 years to get their buy price. Some stocks never recovered!
- Positive panic (frenzy) was also visible in 2007 in real estate stocks. Stocks like unitech were getting land bank valuations (almost like eyeball valuations). When oversupply was hit by the liquidity crisis of 2008, land values crashed and so did stocks. Peaks may never be seen again by investors.
- Negative panic was apparent in march 2009. Us banking collapsed and had to be bailed out by the government. It was a global pandemic. But the liquidity infusion screamed that at 10 times p/e, the equity market was a buy. Frontline stocks and defensives went into a multi-year bull run.
- Gold too became a victim of negative panic in 1999. Technology boom was redefining money supply with electronic money. Reserve currency status was under question. Then the tech meltdown started in 2000 when gold bottomed out at $260/troy ounce. By 2011 it had completed a multi-year bull market at $1900/troy ounce. Again the panic opportunity was missed.
- Let me conclude this point on a slightly futuristic note. Where are you seeing panic at its peak today? It is obviously in infosys. Falling market share, pressure on profitability and employee attrition has made the stock an underperformer in a bull market. We are at an inflection point. The company is transforming into a product company. Bfsi is passé and the focus is smac. This could be the panic situation for you to enter. The choice is yours.
How to identify a panic situation?
Remember the famous wall street quip. When the cabbie and the shoeshine boy start giving you buying ideas, it is a case of frenzy or a positive panic. Just rush for the exit. May be exaggerated but the moral of the story is that the herd is rarely correct in calling the market. When hordes of investors are buying despite the absence of a credible story at screamingly ridiculous valuations, you can be sure that you are in the midst of a positive panic.
What about a negative panic? That is when an asset class becomes an untouchable. This is a universal rule; be it equities, bonds, gold or commodities. When you are convinced that nothing is wrong with the asset, but everything is wrong with public perception, you are close to the bottom of a panic. That is the time to enter and start buying, perception be damned.
Takeaways from the ‘don’t panic’ debate
“don’t panic”, is easier said than implemented in tough conditions. So what are the takeaways? First, let your rulebook guide you in entry and exit decisions, not the mentality of herds. Secondly, panic is the victory of sentiment over reason and no smart investor ever lets that happen. Thirdly, keep yourself from the media barrage, because the media gets its trps from magnifying frenzy at the peak and panic at the bottom. Lastly, make panic work to your advantage.
The golden takeaway is that you are bound to panic if you don’t have a plan-b in place. Markets rarely move to a plan, especially your plan. That is the crux of the issue. When you buy a stock be clear what you will do 20% higher or 20% lower. The day you are clear on this issue, you hardly ever panic. You know that you have only two options; stay put or run for the exits. Have a plan-b for every decision you make. You will be one of the few who outwits the mighty herds, both in panic and in frenzy.