Wednesday, 3 August 2011

Tips to trade during a market slide

One of the basic principles of equity investing is to 'stay invested for the long term.' You have probably heard and read that enough in the past. But when stock markets start to slide, like they did last week, one often questions that principle.
Of course, if you are a trader with open positions, you would need to act in such a scenario. But for small retail investors with a long-term horizon, who hold good quality stocks and funds, there is usually little to worry. That's because equities do give the best results in the long-term. In the short term, the prices of equity shares are driven by traders and speculators who are looking at short term gains. They bet on scrips on the basis of tips and information which may or may not happen. However, over a long period of time, the short term volatilities get evened out and the returns reflect growth that is more realistic.
The crucial point here is 'long-term' and let us take this opportunity to explore what 'long-term' really is.

Let us dip into some empirical research. Refer to the table. Column (2) gives you the value of the Sensex as on the date mentioned in column (1). So as of 31 March 1980, the Sensex level was 129. Column (3) tells you the annual return for each year. So if you had invested on 31 March 1980 and had sold your shares on 31 March 1981, you would have made a return of 34.9%. Column (4) tells you the annualized return on your investment, had you stayed invested for a 3 year period. So if you had invested on 31 March 1980 and sold your shares on 31 March 1983, you would have made an annualised return of 18.1% per annum. The same applies in case of columns 5 to 9. So suppose you had invested on 31 March 1980 and stayed invested for 20 years, you would have made 20.09% per annum.
Now let us come down to the last two rows of the table. The probability of loss shows your chances of losing money for each holding period. So if you had stayed invested in the Sensex for any one year during the years 1979 to 2011, you would have lost money in 11 out of the 32 years. If you had stayed invested for any 3 year during that period, you would have lost money 6 out of 30 times.
The average return row shows you the average return for that holding period. So if you had stayed invested for any one year during that period, you would have made an average return of 26.64% per annum. But of course, the average figure is absurd here, because the returns have been negative in many years. Therefore it is important to read the averages along with the probability of loss.
So while your average return would have been 26.64% for any one year holding period, you also stood the chance of losing money 11 out of 32 times.
Now here's the important part: The longer you stayed invested, the lower your average annual return. But the longer you stayed invested, lower the chances of a loss. In fact, if you stayed invested for a 15 or 20 year period, there is a zero possibility of a loss. And that is accompanied by an average return of 16%; still higher than debt instruments and significantly higher than average inflation.
It is safe then to say, that when it comes to equity investing, long-term should be at least 10-15 years. If you have a long way to go (10-15 years) before you need your equity investments, stay put. Don't let the recent bloodbath affect you. If you started investing 7-8 years back and need the money sometime in the near future, start moving your money into debt funds; do it in a phased manner.
Probability of loss11/326/303/283/261/230/180/13
Average return26.6418.8418.3719.5617.0516.2916.74
Deepa Venkatraghvan is a chartered accountant and a personal finance writer. She is also the author of the recently released 'Step by Step Guide to Start Investing'; a book about the basics of investing includinginvesting in equities and the various other investments like debt, mutual funds, gold, commodities, real estate and so on. Easy to understand, practical and immediately useful, this book is an essential guide for anyone looking to make his or her money work for him/her.

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