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Don’t fall for panic buying in stocks

Last Monday’s action on the stock market was a lot like that panic slap. Except that this was an unusual kind of panic, writes Dhirendra Kumar.

business Updated: May 24, 2009 21:24 IST

In movies, sometimes one character slaps another (who is screaming because of an approaching crisis) to snap that person out of a panic. The person starts acting sensibly.

Last Monday’s action on the stock market was a lot like that panic slap. Except that this was an unusual kind of panic.
Over the last couple of decades, I’ve seen a variety of panic-fuelled stampedes in the stock markets, but the severest ones have always been for the exit to avoid losses.

I’d never expected that the worst stampede I would ever see would be in the other direction — that of investors trying to buy stocks at any cost.

Behavioural investing tells us that investors are risk-averse and react far more strongly to the prospect of making
losses rather than making profits. Last Monday was probably proof that there are mysteries to people’s behaviour that will never be understood. The phrase ‘panic buying’ is often used, but what we saw on that day was its one true demonstration. Now, I really know what a buying panic looks like and shall never use the phrase in vain.

However, that doesn’t make the phenomenon any easier to understand. When there’s panic selling in a market, it’s because traders want to sell a stock at any price so as to avoid a loss. But what is a buying panic?Are traders are buying because stocks will never again be available? Perhaps.

The most charitable explanation was that it was actually driven by short-sellers trying to avoid a loss.

While investors were waiting for the illusory ‘post-election dip’ to buy stocks, plenty of speculative short-term traders had taken that dip as a given and had sold stocks. After seeing the election results on Saturday, these people lined up on Monday morning to buy stocks at any price.

However, that’s the kind of thing that short-term traders do. They do go into panics from time and time, and need to be given a tight slap. What’s important for long-term investors is to ignore these shenanigans.

While the stock markets’ gains last week are certainly welcome, it would be easy to overestimate their importance.
You aren’t missing any opportunity of a lifetime by not investing now.

It would be just as foolhardy to rush into equities now as it was to rush out during last October’s panic.