For both the above reasons, stock market movements are not entirely rational. However, there is a method to the madness.

By Hemanth Gorur

The first quarter of 2020 witnessed a bloodbath on the bourses. From a high of 41,952 on January 14, 2020, the stock markets plummeted to a 39-month low of 25,981 on March 23, 2020. The last time the BSE Sensex had been at a similar level was December 26, 2016, after which there had been a steady and secular long term uptrend.

Should investors be worried? Yes and no. Let’s analyse.

Psychology of the markets
There are a few unassailable truths about stock markets. First, they are mostly driven by human psychology. Notwithstanding the use of computing muscle in algorithmic trading, stock prices are driven by human greed, fear, and expectation.

Second, stock markets factor in future or expected changes in business and sociopolitical environment, rather than past developments. For both the above reasons, stock market movements are not entirely rational. However, there is a method to the madness.

Third, declines or downtrends are much steeper than uptrends. That is something investors should expect when they see the markets tumbling.

What’s the market doing today
Let us see what the Sensex has been doing. The last time we saw such a precipitous drop was in 2008 when it lost around 60% of its uptrend gains in a year’s time. This was after it had taken around 4.5 years to reach around 20,800 during a bull run that had begun in May 2003.

Typically, after every major bull run or uptrend, the Sensex enters a ‘downtrend-and-recover’ cycle where the downtrend-and-recover period would be roughly two-thirds of the uptrend period. The downtrend period, in turn, is roughly one-third of the downtrend-and-recover period. During the downtrend, the Sensex tends to shed around 60% of the gains made in the preceding uptrend.

What should an investor do?
First, do not panic and convert paper losses to real losses by selling your shares just because their current price levels are below cost. Analyse the markets and study your investment goals. The Sensex closed May at 32,424 and is on an uptrend. It is expected to hit a resistance level of around 35,000 in the next two months or so, before reversing into a downtrend with a support level of around 25,000 by year end. Depending on various factors, there may be another cycle of uptrend and downtrend hitting resistance and support levels of around 30,000 and 20,000 respectively, after which the next major bull run may commence.

So, if you are a long-term investor who started investing anytime in the last four years, do not sell your holdings unless there is an emergency and cash in hand is priority. You are better off waiting until the Sensex recovers to its January 2020 levels, which it may in 3-4 years’ time.

If you are a medium term investor looking to exit the market, keep an eye on market trends and sell on the next uptrend only if market price is above cost.

If you are looking to invest, you may not get a better opportunity. You can time your buys in the next one year to coincide with the downtrend-to-uptrend reversals, or when the markets have bottomed out.

Remember that the above are only guidelines based on expected market movements and no substitute for your own analysis or a professional financial planner’s advice. Take investment decisions carefully, smartly, and with patience.

The writer is co-founder, Hermoneytalks.com