Stock market corrections, like those unfolding in recent months, can be challenging for investors. Yet, they also offer opportunities for those who navigate them wisely. Here are some common mistakes that hinder investors’ ability to tap them.

One of the most common errors investors make is viewing stocks solely from a drawdown perspective, the peak-to-trough decline in a specific period. While drawdowns can signal some potential opportunities, fixating on them can lead to poor decision-making. Investors often become overly focused on how much a stock has fallen from its peak rather than considering its intrinsic value and future potential. This can result in buying falling stocks as they appear cheap relative to previous highs. As we have seen over an extended bull market over the last four years, this mental framework can be deceptive.

Another critical error investors often make during corrections is seeking value in the same places where they recently made huge gains, like small- and micro-cap stocks, or “story-driven” stocks. While these can offer high growth potential, they also come with significant risks, especially during market downturns, as such firms often lack the financial stability and market depth to weather economic downturns.

This approach of investing only in aggressively rising themes of the market, is reflected in the inflow data of mutual funds, where many small and thematic funds raised a large corpus in the last three years. This meant investors were avoiding large-cap equities and other investment products, creating a portfolio imbalance.

Too many stocks

In recent years, the Indian stock market has seen a significant expansion, with over 1,000 new stocks added in five years, many of them representing novel business models. This poses a challenge as attempting to follow too many stocks can lead to information overload, making it difficult to make informed decisions. This “bandwidth issue” can result in hasty decisions based on incomplete information. Investors are advised to stick to a universe of stocks based on preferred criteria.

*One of the most dangerous assumptions investors can make during a correction is expecting a rapid market recovery. Historical data shows market recoveries can take considerable time, and portfolios focused on narrow themes or sectors may take even longer to regain ground.

In India, there have been several instances where market recoveries took longer than anticipated. The 2008 global financial crisis triggered a 50% drop in the market, which only regained its pre-crisis level in 2010. More recently, the small-cap index fell close to 50% during the 2018 meltdown and took three years to hit a new high, reflecting the prolonged period to recover from it.

Another mistake to avoid is overexposing portfolio to narrow themes, such as capex-related stocks or policy-related beneficiaries. They are vulnerable to policy changes and economic shifts.

For instance, the recent focus on public capex has led to an increased interest in infrastructure and related stocks. But capex growth has slowed this year, triggering a correction in some stocks.

Investors are often trained to buy on dips. This has been successful at times. However, this strategy might not work well when the broader economy experiences challenges with growth and inflation, amid elevated stock valuations.

So, navigating market corrections needs discipline, patience and a clear understanding of such common pitfalls. By avoiding these mistakes, investors can position themselves to weather market downturns effectively. Successful investing is not about timing the market or finding the next “hot” stock. It is about building a diversified portfolio with lots of margin of safety, based on policies and rules laid down by you in alignment with your long-term financial goals.

By learning from past market cycles and avoiding common errors, investors can navigate corrections with greater confidence and set themselves up for long-term success. As Benjamin Graham said in ‘The Intelligent Investor’, “Whenever making money becomes effortlessly easy, keeping it is about to become extraordinary hard”.

(The writer is a certified financial planner)

Published on February 10, 2025