With the Nifty and the Bank Nifty consistently quoting at all-time highs, it raises the crucial question of what should investors do? The typical tendency when the market is at an all time high is to book profits and rapidly exit the market. But that may not be the right strategy. Just as a new market low is not necessarily the time to buy, a new market high need not be a time to sell out. Traders and investors can keep these 10 rules in mind to guide them through the markets at all-time highs…
The 10-point rule-book when markets are at an all-time high…
1. The price/earnings (P/E) ratio may be much maligned and much criticised for its various limitations but it still provides the best approximation of market valuation. For example, the Nifty is currently at a forward valuation of around 17 times earnings. This puts the Nifty and Sensex levels in much better perspective. Remember, during the market peaks of 2000, 2008 and 2010 the forward P/E was quoting well above the 27 mark.
2. Check out if there is scepticism in the market. How do you judge that? Check out if the retail investors are generally optimistic or cautious. If you find an unbridled optimism among retail investors it is time to be careful. But if you see retail investors getting cautious at every bounce, then this is not yet the market top.
3. Keep an eye on the institutional activity. Prior to the sharp corrections in 2008 and 2010, we had seen institutions getting negative on the markets. They are the well-informed investors who have access to managements and better insights into the changing dynamics of business. If you find institutions selling consistently, then it is time to be careful.
4. Profit is what is booked; all else is book profits! This old piece of wisdom in the market is very relevant when the market is at an all-time high. Of course, this applies more to your trading positions. When you are targeting 15% returns in 6 months and the stock returns 15% in 1 month, then it is just too good to be true. In such circumstances, you must look for the exits if it is part of your trading portfolio.
5. This is the time to restructure your portfolio. A sharp rally, like the one we saw since the beginning of 2017, normally takes a lot of good and bad stocks up along with it. This is the time to get out of speculative stocks and park your money in long term growth stories. In the process, you may rue some missed profits but that is a risk worth taking. In fact, the most important decision you need to take at market highs is to restructure your portfolio.
6. A market high is the time to snatch growth and not try to identify deep value. Many investors live under the delusion that the best strategy at market highs is to buy into beaten down sectors like IT, pharma etc in the current context. But that may not work in a market high. At these levels, momentum will always be king. The stocks that drove the rally in the first place will be the ones to drive further. It is time to ride the momentum not to look for deep value opportunities.
7. Keep liquidity handy when the market is at highs. For example, you can look to keep around 10% of your portfolio allocation in liquid form so that any disruptive correction in the market can be used to pick these momentum stocks at more attractive prices. A new high does not mean that the markets will be linearly up. There will be disruptions along the way and that is where liquidity can help you.
8. Make the best use of rolling stop losses. At the end of the day, what matters is not what the stock returns but what you earn on the stock. Apart from identifying the right stocks to buy, you also need to protect your profits. A rolling stop loss is a good strategy when the market is at a new high. Such rolling stop losses levels can be constantly revised upwards, but that discipline is a must to protect your downside risk.
9. Learn to use derivatives intelligently in such markets. You can substitute your long equity position with long futures or with a call option. Such derivatives work quite well in trending markets. Also you can look at put options to protect your risk and also to make money in market volatility. A focus on equity alone can make your portfolio approach too rigid. Adding a flavour of derivatives gives you a lot more flexibility.
10. Lastly, watch out for that one factor that has driven this rally in the first place. It could be earnings; it could be liquidity; it could be fund flows or it could be domestic reform related factors. If you want to know when the market will top, you need to look out for signs of this core driver of the rally reversing. The moment you see that signal, it is time to get cautious and prepare alternate course of action.
This rally owes as much to investors’ faith in the India story, as it does to the relentless flow liquidity. Nobody has consistently called the market top correctly; perhaps nobody ever will. The best you can do is to adopt a framework of rules to make the best of market highs!