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Stock Market: Some signs of an impending crash

After stock market correction since Jan'08 there are many learnings for new/first time investors to protect their investment and minimize losses. How do you predict a fall in the markets? Tell-tale signs you need to look out for.

The domestic Indian markets as well as global markets are going through a long-term bull run that started in the year 2003. We have seen many phases of rallies making new highs and consolidation thereafter in this long-term bull market. This phase of the market can be attributed to several factors including globalisation that resulted in work from abroad (outsourcing) and funds, opening up of the economy, and relative isolation of the domestic markets from the slowdown in developed markets. However, this phenomenal growth in the market has made it quite volatile.

We see markets react very quickly and sharply to any news and events. Last few months were some of the most volatile months for the domestic/International markets. We have seen panic selling on the first two days of the week triggered by news of a slowdown in the global economic activities. All key market indices fell over 20 percent in just a couple of days, and then the market recovered quickly to register the biggest single day gain then slipped again to the lows.

Every investor in the market likes to invest at the bottom and exit at the top. This is difficult as it is almost impossible even for market analysts to time the market. But smart investors try to read the market signals to guess the possible direction of broader markets. These are some triggers or indicators that can point to a possible correction in the near term. Investors should be cautious on fresh investments in the market and should start booking profits when one or more of these symptoms show up.

Global News and Events

Global events have a direct or indirect impact on the domestic stock markets. Investors can keep an eye on news from global markets (sales and employment data from US markets, news/action on USA sub-prime crisis), economic events and announcements at the global level (US Federal Reserve meetings/announcements), global market movements etc to get a sense of movements of the domestic markets in the short term.

Stretched Valuation

The market valuation is the sum of individual stocks' valuations. The valuation of a stock is derived from its expected future performance. In a bull market, stocks have a tendency to surpass their true valuation. When a lot of stocks go way beyond their true valuations, the market looks over-valued and signals a correction

Liquidity

Liquidity increases the risk appetite in the market, and as a result, pushes the market up. Therefore, any signals that indicate tightening of liquidity (actions of US Fed, Japanese Central Bank, RBI actions etc) may lead to a fall in the stock markets.

Fluctuations in Commodities

Commodities are used by traders the world over for hedging. Increased activities in the commodities market (especially gold and crude) also give an indication of a possible correction in the stock markets. Also, higher crude oil prices threaten the growth of the world economy, and hence, sharp upward movements in crude oil may trigger a market fall.

Government Actions

The government is the policy maker in a country. Therefore, stability of the government, new policies or changes in the existing policies is very closely tracked by the stock market. Any bad news on this front can trigger a sell off in the market. However, the happening of one or more of these factors does not guarantee a fall in the stock markets and investors should not try to time the market. They should invest in the market with a well thought-out strategy.

These are some tried and Tested Strategies:

• Invest with a long-term horizon. It is not advisable for investors to trade in the market for short-term gains.

• Do not invest blindly in the stock markets. Analyze your investments and always maintain a profit/loss target on your investments. Book partial or full profit/loss in case your targets are triggered.

• Since the stock markets are quite volatile, keep a constant eye on your investments. If you cannot track your investments, you will be better off keeping your money in bank fixed deposits or mutual funds.

• Look for diversification of investments. Do not invest in one market instrument. Analyze your risk profile and accordingly invest in proportions into various instruments (stocks, equity and debt mutual funds, bank fixed deposits etc).

• Investors should invest their own risk money in the stock markets. This means investors should have enough liquidity in hand after investing in the stock markets. Investors should not borrow (take loan) to invest in the stock markets.

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