After a sustained period of record highs, markets have entered a corrective phase over the past few trading sessions.

The question on everyone’s mind: is now the right time to lock in profits, or should you hold tight to your portfolio amidst the current anxieties?

Many investors tend to start selling their holdings in losses or stay completely away from markets during these phases. However, if we trust the history of markets and wisdom of experienced investors, these are the times when ideally one should be investing in good quality companies.

Let’s understand more about this.

What is a correction?

At their core, stock markets rely heavily on investor sentiment. Positive sentiment attracts money into the market, while negative sentiment leads to sell offs. In recent years, we’ve witnessed a surge in market participation following the pandemic. This significant increase has fueled a major rally, further bolstered by rising earnings from listed companies. Since Covid 19 low in March 2020, Nifty50 has almost grown 3 times in 4 years. That’s more than 30% returns on an annual basis.

A correction is a natural process where markets attempt to adjust prices in anticipation of an upcoming slowdown in the business cycle or any of the multiple factors that affect investor sentiments. During this phase, market participants tend to lock in profits, leading to sustained selling pressure due to this outflow of funds. This ultimately results in corrections and a downward trend in the market.

History is replete with examples of market corrections ultimately leading to greater wealth creation. Take, for instance, the global financial crisis of 2008. Or Covid 19 crisis of 2020. Many investors panicked and sold their stocks, fearing further losses. However, those who remained steadfast and continued to invest or even increased their investments during that period were handsomely rewarded as markets recovered.

What should you do in the current situation?

Corrections present an opportunity to buy quality assets at a discount. Since nobody can predict the exact market peaks and troughs, a sensible strategy is to consistently invest throughout these cycles, averaging your portfolio cost. Let’s illustrate this with a recent example.

Since October 17th of 2023, markets dipped from around 19,800 to a low of 18,800 before rebounding. Not only did they surpass their previous highs in the following months, but they’ve been setting new records ever since. Today, it’s close to 22,000.

Think of it this way: when your favorite store has a sale, you don’t avoid shopping altogether; you seize the opportunity to buy things you’ve been eyeing at a lower price. The same principle applies to the stock market. Quality stocks that were previously out of reach may now be within your budget, thanks to the correction.

In such times you must ask some fundamental questions about markets and your own investment goals in order to get clarity about what you must do.

Here is a list of questions that will help you in getting clarity with your investments

Q1. What is my timeframe for investment?

Your investment timeframe significantly impacts how you should approach a market correction. Here’s how it can influence your decisions.

If you need your money within a few years, corrections can be riskier. You may want to prioritize capital preservation by holding lower-risk investments or increasing your cash allocation.

With a long horizon, corrections become less concerning. You can potentially use them to accumulate shares of quality companies at a discount, aiming to benefit from their long-term growth.

Q2. Are the companies in my portfolio resilient enough to handle a negative business cycle or two and survive the same and come back profitably?

Evaluating your portfolio’s resilience is crucial during corrections. You can do this by evaluating the financials of the companies that you are holding, their business model and the trend in the industry to get clarity on the above question. If you need help, you can view various Collections that Share.Market offers on its platform to give you a starting point.

If you need more help, you can check the WealthBaskets, a basket of stocks / ETFs curated by our SEBI registered Research arm, which will guide you through your investment journey.

Q3. How much risk am I comfortable with? 

Re-evaluate your risk tolerance in a volatile market. Can you stomach short-term losses for potential long-term gains?

Q4. Is my portfolio diversified across sectors and asset classes? 

A diversified portfolio helps mitigate risk. Is yours spread out or heavily concentrated in a specific sector that’s being hit hard by the correction?

Q5. What are the specific reasons behind the market correction? 

Is it a healthy and normal market correction or a sector-specific downturn? Is the correction because of global reasons or domestic reasons? Understanding the cause can help gauge the potential impact on your holdings.

Q6. How are the companies in my portfolio performing compared to their historical averages and industry peers? 

A temporary dip might be an opportunity if the company’s fundamentals remain strong. Check out “Reliable Choices” and “Bargain Hunt” Collections on Share.Market to give you a starting point.

Q7. Am I making investment decisions based on emotions (fear or greed)? 

This is the most important question. Most people make emotional decisions and sell their winning stocks early, as soon as they see a slight bit of correction. This is called the Disposition Effect. Try to be in the top rational investors club and focus on long-term goals.

Q8. Do I have additional capital available to invest during a downturn? 

If your risk tolerance allows, corrections can present opportunities to buy quality stocks at a discount.

Conclusion

Corrections are part and parcel of the markets and one cannot avoid the drawdowns that come along with them. It is important to reevaluate your risk tolerance, avoid emotional decision-making, and stick to your long-term investment strategy during such times. So stay focused on your goals and make decisions based on careful analysis and research to prevail during such times.