3 Stock Market Fears and How to Protect Yourself
May 6, 2021
The stock market is characterized by complex dynamics that often throw a wrench in the works for traders, thwarting analyses, estimates, and predictions. All of this is part of the allure that, even today, is attributed to the stock market, but it is undeniable that it should also and above all be analyzed from a technical point of view, in an attempt to reduce risks and minimize potential losses.
In light of this, it is important to take stock of three particularly dangerous events that, from time to time, occur in the stock market and generate fear and even panic among investors, especially those with a more prudent and measured approach. It is also important to provide general advice - but within everyone's reach - to defend against or, in the worst-case scenario, limit the negative effects.
One clarification: the events we will analyze are not always exclusive to the stock market; they could also occur in other markets. However, it is precisely in the stock market that they express their purest and, consequently, most dangerous version.
The peculiarities of the stock market
But why the stock market? What are the reasons why, precisely among its ganglia, the conditions for the explosion of the events in question are triggered?
One of the reasons could be the extreme variety of the stock market. Many markets are composed of a rather limited number of assets. The energy sector, for example, has very few. Even Forex is limited to a few dozen pairs, at worst (or best). The stock market, on the other hand, has thousands upon thousands of stocks. Of course, it is possible to trace segments and trends, so many stocks move almost in lockstep, but in any case, the variety is significant. Therefore, the probabilities that something will "go wrong" and give rise to a sort of domino effect or trigger unpredictable dynamics are statistically numerous.
Another reason lies in the interdependence between the stock market and the "outside world," i.e., the economic, political, and even social context. Stocks are, in the most conservative of hypotheses, heavily influenced by the performance of the issuing company in the market in which it operates. However, a profound impact is also exerted by the performance of the sector as a whole and even by the real economy in general. Therefore, numerous events regularly come into play that can trigger significant and, at the same time, unpredictable dynamics.
Finally, the simultaneous presence of a large number of investors should also be noted. In general, this represents a defense against market manipulations, but it can also generate unexpected or not entirely desirable effects. For example, when masses of investors form who all behave in the same way. A bit like avalanches that grow as they descend the valley, groups of investors - automatically, without prior agreements, of course - can generate extreme dynamics.
The 3 bogeymen of the stock market
That said, what are the bogeymen of the stock market? What are the events that frighten traders and put their capital at risk? Here are the three main ones, or at least those capable of striking the collective imagination.
Corrections
We speak of a correction when a stock sees its price reduce suddenly. So far, at least apparently, there would be nothing strange. However, corrections are particular for at least two reasons. Firstly, they act apparently against the trend. In fact, we only speak of a correction if the decline is grafted within an upward trend. This generates a stir, as it disavows what seemed to be a given: the stock was growing. Also by virtue of this, the effect is amplified.
Corrections are also particular because they are by definition deep and rapid. We are talking about a radical drop, which can exceed 10% of the overall value of the stock. It is obvious that we are beyond the concept of rationality, and the decline does not correspond to a change in concrete conditions but rather to an emotional dynamic.
Panic selling
The concept of panic selling is well known even outside the stock market, even beyond the world of investments. After all, the phrase "panic on the stock exchange" is part of common language. Yet the expression is anything but exaggerated: we are talking about movements that truly express a condition, if not of panic, at least of emotional upheaval. Panic selling, in fact, translates into selling the stock at all costs.
It is obvious that, in such a context, the stock risks losing much of its value. Moreover, panic selling is to some extent contagious, so it can create serious headaches and have an extremely negative impact on traders' capital.
Suspension of trading
Finally, the suspension of trading, or the momentary interruption of trading. More than an uncontrolled and indomitable dynamic, it is a precise safety mechanism provided by the authorities. However, its occurrence is terrifying both for the consequences it generates and for the reasons that normally lie behind the suspension.
The stock can be suspended for two reasons. Firstly, because it has been the protagonist of strong oscillations in a short time, even exceeding 10%. Let's be clear, we are talking about oscillations, so suspension for excess increase is also conceivable.
Secondly, the stock can be suspended at the request of the issuing company itself, as it must disseminate important information that can have a profound impact on the market. Even this eventuality, however much "controlled," causes fear, as the trader may feel defenseless and unable to react preventively, as he is unaware of what, shortly thereafter, will be a powerful market mover.
How to defend yourself
How can the trader react to these bogeymen? How can he safeguard capital and, if possible, even profit from such events? These are the classic million-dollar questions. However, it is clearly possible and indeed desirable to adopt measures to avoid being harmed by corrections, panic selling, and suspensions. It is much more complex to ride the tiger and even benefit from these events. Some great investors manage to do so, others try and fail.
In any case, it is possible to provide some advice for coming to terms with these bogeymen, both from a psychological and a purely technical point of view.
As for corrections, it is important to frame the phenomenon and look beyond appearances. Normally, this is sufficient to react at least from a psychological point of view, avoiding an over-reaction that could prove counterproductive. In a nutshell, it is important to be aware that corrections last a very short time, and that the market almost always compensates for them. In fact, in the vast majority of cases, the trend resumes its upward path, as if nothing had happened.
A similar discourse can be made regarding panic selling, except that we are dealing with an even more intense and therefore potentially dangerous phenomenon. Panic selling is also normally compensated for, but the time horizon can be broad, if only because it sometimes explodes not during an upward trend, but during a downward phase. Moreover, panic selling in its purest and most "radical" form can cause changes that, if not exactly irreversible, are at least long-lasting. Some traders "solve it" by exiting the market at the first signs, before the stock begins to lose value at an unnatural pace, but it is obvious that this move has its drawbacks.
Finally, the suspension of trading. In that case, there is very little that can be done. Also because, from a purely technical point of view, nothing can be done at all: the stock is no longer available. The trader's attention should be directed to the informational issue. It is obvious that, especially in the case of "suspensions on request," it is the fresh information that moves the market as soon as the stock is made available, like a river that flows after breaking a dam. The advice, therefore, is to try to at least intuit the sign of this information and monitor the situation minute by minute, second by second, in order to react promptly.
A piece of advice that can apply to all three phenomena, and which concerns the complex issue of psychology. Regardless of the real danger they pose, corrections, panic selling, and suspensions have an impact on the emotional level. In a sense, they put the trader's composure to the test. Therefore, train your psyche to resist the tumults of the market, not to suppress emotions (which is impossible in itself) but to render them harmless. Regardless of what is happening, they should not be the driving force behind your actions, at least not in trading. If your goal is to successfully frequent the markets, rationality is the only guiding star that can lead you to profit.
