Markets: The second rule…

Source: EM

Wikipidea defines a stock market crash as ‘a sudden dramatic decline of stock prices across a significant cross-section of a market.’ It further states that crashes are driven by panic as much as by underlying economic factors. They often follow speculative stock market bubbles such as the dot-com boom.’ Now, if one were to take note of the ‘crash’ that has been witnessed in Indian stock markets over the past week (with the Sensex declining by 17% in just eight trading sessions), it is more driven by panic selling than any weak economic factors.

History is replete with examples when greed and fear have taken over discipline, resulting into windfall gains and, of course, ‘windfall’ losses for investors. And more sadly, small investors are the biggest losers in these phases of indiscipline (one can hear endless stories about losses made in the latest crash). While greed results into bulls taking the centre-stage and leading markets towards nauseatingly high levels, fear brings them back to ground zero. And small investors suffer in both these situations.

As market participants face the heat of the moment, long-term investors need to manage fear. Panic selling would serve no purpose and if the company has strong fundamentals, the stock is more than likely to bounce back. As Warren Buffet said, “I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.”

Pressure times like these calls for high levels of discipline and, in these times, two key rules of investing from Benjamin Graham should be held in high regard. The two rules are:

  1. Don’t lose money, and

  2. Don’t forget the first rule.

While investors ardently wish to follow the first rule, in this devotion, they tend to forget the second and the more important one. If, and only if, investors could practice the second rule, the first one would need no effort.

We suggest investors to look at the current decline as an investment opportunity for the long-term.

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