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5 Things to Note Before Selling In A Volatile Market

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5 Things to Note Before Selling In A Volatile Market

The text below is a small extract from the latest memo of Howard Marks, Chairman of Oaktree Capital, to his clients. The entire memo has been made available on the Oaktree website and can be accessed here.

The recent volatility in the world's markets, the S&P 500's 11% drop between August 17 and 25, and the decline of nearly 40% in Chinese equities have given investors an opportunity to experience something else that's not easy: portfolio management under adverse conditions.

A few lessons are worth noting, none of which are always easy to employ:

"Investors can be tempted to sell during corrections like this one. Oftentimes emotional behaviour is cloaked in intelligent-sounding rationalisations like "it's important to sell down to your comfort level." But the valid reasons to sell are principally because you feel fundamentals have deteriorated or because the price has risen enough.

Selling to get more comfortable as prices fall (just like buying for that purpose in a rising market) has nothing to do with the relationship between price and value.

Another reason to sell, of course, is fear that the slide will continue. But if you're tempted to do so, ask yourself first whether you think the stock market is going to rise or fall tomorrow, and second how much you'd bet on it. If you can tackle those decisions in your head rather than your gut, you'll probably admit you have no idea what's going to happen in the short term.

Regardless of the outlook for fundamentals or the relationship between price and value, many people sell in a downdraft because, well, you have to do something, and they feel it's unreasonably passive to just sit there.

But something about which I feel strongly is that it's not the things you buy and sell that make you money; it's the things you hold. Of course you have to buy things in order to hold them. But my point is that transactions merely adjust what you own, and engaging in them doesn't necessarily increase potential profit. Sticking with what you own may be enough – although it may not be easy in tough times.

"Two of the main reasons people sell stocks are because they go up and because they go down.When they go up, people who hold them become afraid that if they don't sell, they'll give back their profit, kick themselves, and be second-guessed by their bosses and clients. And when they go down, they worry that they'll fall further.

There may be absolutely no intellectual justification for that feeling. If you liked it a month ago at $80, should you sell it now just because it's at $60? The best way to get through a downdraft is to verify your thesis, tighten your seatbelt and hang on. If you sell just because there's a downdraft (or an updraft), you'll never get that twenty-year winner. When you look closely, you'll see that every twenty-year rise included a lot of ups and downs. To enjoy long-term success, you have to hold through them.

Especially during downdrafts, many investors impute intelligence to the market and look to it to tell them what's going on and what to do about it. This is one of the biggest mistakes you can make. As Ben Graham pointed out, the day-to-day market isn't a fundamental analyst; it's a barometer of investor sentiment. You just can't take it too seriously. Market participants have limited insight into what's really happening in terms of fundamentals, and any intelligence that could be behind their buys and sells is obscured by their emotional swings.

It would be wrong to interpret the recent worldwide drop as meaning the market "knows" tough times lay ahead. Rather, China came out with some negative news and people panicked, especially Chinese investors who had bought stocks on margin and perhaps were experiencing their first serious market correction. Their selling prompted investors in the U.S. and elsewhere to sell also, believing that the market decline in China signaled serious implications for the Chinese economy and others. The analysis of fundamentals and valuation should dictate an investor's behavior, not the actions of others. If you let the investing herd – which determines market movements – tell you what to do, how can you expect to outperform?

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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