Profit from volatility


Executive editor’s Note:

Stock market, by nature, is volatile. Sometimes the volatility becomes excessive as in recent weeks. When positive and negative forces emerge in quick succession, market oscillates between optimism and pessimism, favoring bulls and bears in alternative bouts of buying and selling. This kind of oscillation swings the short-term trading strategy from ‘buy on dips’ to ‘sell on rallies’ and back again. This can be profitable/painful for traders, depending on the success of their trading strategies. But for investors, this excessive volatility can be a good opportunity.

Often, the market overreacts: both to good news and bad news. Over reaction to bad news can be a great opportunity to buy. In fact, buying on bad news when the market has overreacted to bad news is a foolproof investment strategy, provided the stock selected for investment is a quality stock undergoing a temporary dip.  For instance, in July 2012, when trouble broke out in Maruti’s Manesar plant resulting in the killing of a company executive, injuring many officials and shutting down of the plant, the market overreacted to the news and the bears hammered the stock. This proved to be a great opportunity for long-term investors who accumulated the stock at bargain prices and made a fortune when things came back to normalcy. There are many examples like this when buying on bad news became a very successful investment strategy. It is important to remember that this strategy will be effective in the case of large-cap blue chips; but when applied in mid-and small-caps the strategy can be highly risky.

Buy on bad news strategy becomes simple (in retrospect) during sharp market crashes when blue chips become cheap due to widespread market pessimism. This happened during the market crashes of 1992, 2000, 2008 and 2013 when valuations became compelling. During such market crashes, stock selection becomes easy. But the investor needs the courage to buy, the stomach to suffer some more pain during the downturn and more importantly, the patience to hold.

Presently, the market is going though a volatile phase, and this presents opportunities to buy on dips. But it is important to appreciate the fact that even after the correction, the market is not cheap. But on a bad day, reacting to bad news, the market will overact making the price of certain stocks attractive to investors.

The coming days are likely to witness high volatility in the market. High volatility in crude price, swings in the US bond yields, corporate results and concerns relating to the upcoming state elections are likely to contribute to this volatility. Investors can profit from this volatility. Also, this volatility is a great opportunity to churn the portfolio and remove the weeds.

This issue of Geojit Insights carries insightful articles on the economy and markets. The cover story is on ‘Market Outlook: Opportunities & challenges for the retail investor’ by the renowned fund manager S Krishnakumar, CIO Sundaram MF. SmartTalk is by Alok Agarwal, Fund Manager, DHFL Pramerica MF. As always there are valuable inputs from our in-house experts. Happy reading!


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