During a market sell-off when investors get rid of assets and stocks in large volume very quickly, it is easier to make mistakes that can negatively affect your trading accounts and financial portfolios. This is because many traders are simply following the “herd” and basing decisions on sentiment rather than logic and reasoning.
When everyone is selling stocks, for example, in a sector that is struggling due to a series of poor quarterly reports, there is a tendency to only think about the short-term and fall prey to the natural desire to get out of a market that is sinking in order to lock in previous gains or mitigate future losses. While this may be a prudent move, you should take time to consider other factors and make sure that you are doing the right thing during a stock market sell-off.
From shorting CFDs and buying put options to opting for safe-haven assets and buying dips, there are certain strategies you can implement to succeed. Reading articles from a leading financial consultant will prepare you best for times when there is a broader sell-off in financial markets. Avoiding these common mistakes will help too.
Panic-selling
When everyone is selling, there is obviously a tendency to follow the same patterns as other traders. However, this can lead to panic selling and swift exits from positions without considering the long-term consequences. Selling into a market that is on the decline can lock in your own losses, which can be difficult to recover from.
Again, while cashing out might be the right course of action, you should first consider taking a long view, especially if you have a diverse portfolio with stocks in a range of sectors. Downturns are always inevitable and, on the vast majority of occasions, are only temporary. You only need to look at the history of stock markets to see that strong rebounds are possible. By sitting tight during a sell-off, you could reap the rewards. If you don’t need the cash, always consider the pros and cons of a quick sell.
Being overconfident about “bargain” buys
Business investors also see market sell-offs as a prime time to jump in and buy the stock at low prices with the promise of driving gains when a stock eventually rebounds. While this is a good strategy, in theory, many overestimate their ability to identify stocks that offer value in these circumstances. They also make the mistake of buying a stock when it still is on a downward trajectory, which can lead to substantial losses.
The key here is not to be overconfident about the moves you make and, most importantly, not make decisions based only on your research. Using the social trading tools available with brokers could give you an idea about the best trading patterns, as can talking to a financial advisor about your portfolio. You should consider factors like risk tolerance, and length of positions to determine what stocks are right to buy and sell.
Trying to recover losses immediately
A natural consequence of a downturn in the market is making a loss on investments that are on the decline. If you decide to cut your losses and exit a position, it is important that you don’t follow that up with a rash decision about another asset in an attempt to recover those losses quickly. This can lead to poor decision-making and bad stock choices.
Experts also warn against holding on to stock too long when the common sentiment suggests that it should be sold. The right thing to do here is to only hold onto stock if you plan on going long and waiting for the market to rebound. If you can diversify your portfolio with some stocks that are rising, you will be in a better position to weather the market storm.
Forgetting about rebalancing
The last point is linked to the act of rebalancing, which is the process of realigning the weighting of stocks so that your account is at an optimal level for the current environment. Asset allocation can be compromised during a sell-off – so this is a good time to take a step back and consider how things can be changed. Studies suggest rebalancing is better for risk-adjusted returns at these times, though the costs of transactions and tax need to be factored in.
The prospect of losses during a market sell-off can trigger rash decision-making and poor choices, especially if the market is volatile and traders are heading to the sidelines to protect their investment. However, by being aware of common pitfalls, guarding against them, and making shrewd, logical decisions, you can come out the other side in a better place.
