The stock markets oscillate from one extreme to another before they settle down at a realistic level reflecting economic fundamentals. Even at the micro level, the stock price of a company must find its true level sooner or later. The recent market crash worldwide was quite severe in its impact and took a heavy toll on both investors and speculators. Those who were fortunate to ride this storm in the stock markets have a lot to gain if they do a rational analysis of how stocks behaved during this prolonged depression.

There are some important lessons to be drawn from the financial crisis and the subsequent market meltdown.

*There are no blue chips. They change colours with time. If you own a blue chip, do not live under the illusion that it will remain unaffected or less affected than the ordinary stocks in the market. When sentiment is badly battered by a chain of disastrous events in the global economy, even blue chips are not spared. It is important to read the signals of a slowdown which are visible to the naked eye if you care to read the news and understand its implications.

For instance, a steady loss of jobs, drop in manufacturing output, rise in external debt levels are tell-tale signs of impending trouble. The formula is simple: See RED- start selling ruthlessly. See GREEN- start buying.

*You have to book profits at every major step or peak in a rally and shut out losses when the market corrects. This way you keep your liquidity intact and are armed with funds to capitalize on opportunities to buy as and when they come your way.

*Never stretch your resources thin by having more than 15-20 companies in your stock portfolio. It just does not pay. You can never get all your decisions right. There will always be a few rotten eggs which can destroy portfolio.

*Beyond a point, there is no merit in diversification. Do not put all your savings in a single asset class. No asset class is recession-proof. Even government bonds erode in value as investors opt for cash in a falling market. Allocate resources according to your risk profile and return expectations. The last stock market crash showed us how prices of commodities, oil, stocks, debt instruments fall across the board when there is panic in the markets.

*Keep your priorities clear and avoid being influenced by analysts and TV commentators who can confuse you by presenting divergent views at a given point in time.

*Cash is king. In times of a major crisis, it is prudent to convert a major part of your holdings into cash. This serves to mitigate the pains of a collapsing financial order.

The global economy is highly integrated and the fortunes of countries are inextricably linked to each other. If, for instance, the US economy shrinks, many emerging markets are badly affected as their exports fall and currencies take a beating. Foreign investors beat a hasty retreat, leading to a heavy outflow of capital from a country. Stocks are sold at ridiculous prices to meet redemption pressures at mutual funds and hedge funds. This triggers a crisis and leaves its debris on the stock markets. It is prudent to unlock value at regular intervals before the stock market hits a bottom. If you have managed to salvage your capital, you will get another opportunity to recoup your losses when the turnaround happens.

Learn more about this author, Dheer Kothari.
Click here to send this author comments or questions.

---

Add your voice

Know something about Lessons to be learned from the stock market crash?
We want to hear your view. Write now!