Markets: When the going gets tough...

When the going gets tough, investors get going -- literally. They just flee the markets.

And the ones who remain either close their eyes like the pigeon when faced with a ferocious feline, or go bonkers trying every trick in the trade to prevent an erosion in their portfolio.

How you react to the market downturn is a function of what kind of market animal you are. Strategies will be different for a trader and an investor.

If you are an investor but have either borrowed or bought shares on margin, the first important thing to do is to repay the debt and unwind the margin trade. Remain invested only to the extent of your own money.

Investors who are fully invested but have no gearing whatsoever may decide to hold fort. But it might be a good idea to be 15-30 per cent in cash. Revisit the logic of holding those stocks and arrange them in the order of their strength. Chuck the bottom 15-30 per cent value to create cash.

The discipline of having this kind of cash comes to your rescue when the markets actually tank. You will see the market fall as an opportunity to buy your favourite stock at a reduced price. But if you are fully invested, chances are that you may end up selling at lower levels in panic.

Currently, stocks held for over a one-year period are exempt from any capital gains tax if STT has been paid on them. While it is a good idea to hold stocks for the long term, merely holding them for a longer term to avoid paying tax even if the future does not look bright is committing harakiri.

Profits may completely vanish if the fundamentals go wrong or markets tank for reasons beyond your control. So hold stocks for the long term if they continue to look attractive and the fundamentals are intact or becoming better. If fundamentals warrant a sell, exit. The tax angle will come in only if you make money. Do that first.

You can also utilise the downtrend to weed out the wrong stocks from your portfolio. Reducing the number of stocks will enable a closer and tighter monitoring of the portfolio.

Then you may want to hedge against further erosion in your portfolio. There are many ways to hedge. One is to buy puts for the current month in stocks concerned, provided the stock is traded in the derivative segment.

The chances of finding a liquid and rightly priced put are very remote, barring a handful of leading stocks. So you may have to buy the Nifty put. But when markets are down, the pricing of the Nifty puts would also be on the stiffer side. More importantly, buying a Nifty put may not protect you, because your stocks may not necessarily move in tandem with the Nifty.

A classic dilemma is: how much to hedge? As hedging comes at a cost, it might be a good idea to hedge only third of your long-term investment.

If you are a trader, you are best placed to harness the current volatility to your advantage. But as per the statistics on the ground, less than 5 per cent of the self-professed traders actually have the nerves to go out and short. My advice to long-only traders is to simply abstain when things don't go right.

If you are long and your stock is going down, put a tight-stop loss or buy a put in the stock or index concerned.

But if you have to panic and exit, it's better to panic early.

I have observed that when the markets tumble, the traders with very low risk-taking ability are the ones to be thrown out of the markets first and escape with minor bruises. And those with deep pockets are the last ones to leave the arena. They are the ones that take the largest hit in a downturn.

So don't fight or argue with the markets, specially if you have leveraged positions. The markets can remain insane longer than you can remain solvent.