The year 2020 and the year 2021, have seen the highest amount of short squeezes. Especially in the foreign markets. The number of short squeezes that have happened will remain in the talks for years in the financial news media.
Let us now focus on; what is short selling? What is short squeezing? And, how does it affect the stock market crash?
Short selling refers to the act of selling the borrowed shares in the market. With an idea of buying the same, after the price is lower than the borrowing price. So the difference between the borrowing price and purchasing price is the profit.
Short squeezing is when a mass of short-sellers start buying at the current market price. So it creates a ruckus in the market, and everyone starts following the trend, which then pushes the price to make new highs. The buying in the market sends the price higher and, to minimize their losses, short sellers start buying.
As it is a common saying in the financial market, that the trader’s confidence involves them in leverage trading, and leverage trading turns the correction into a crash. And, in short-squeezing, a huge amount is circulated within the market. This amount is speculated to be a margin amount that traders are allotted from brokers. It is called margin trading.
Margin trading is an act performed by the trader by borrowing money from the stockbroker. It is similar to leverage trading. The margin money can also be called leveraged or borrowed money.
However, these are constituents of a bull run. These things are normal when the market only makes all-time highs. Also, even 5-10% market corrections are normal in a bull run.
On 26th Feb 2021, one of the major indices of the Indian Stock Market, the Nifty50, corrected by approximately 3.7%. And, as of Aug 11, 2021, the Nifty50 is near to it’s all-time high. So, leverage or margin trading works both ways. One more reason for this can be, ease of demat account opening and availability of online trading apps.
Thus, this is one reason why the market can crash. And, here are three reasons not to worry about a market crash.
The legendary investor/fund manager/author Mr. Peter Lynch once said “People lose more money, anticipating the crash, than at the time of the real crash” This is true, even when we know that the market is marginally high in terms of valuation, and the economy is not supporting it at all. The market keeps on achieving all-time highs. Investors who do not invest, lose more money while anticipating the market.
Therefore, one should stop timing the market, and keep patience even if the market crashes. Invest in fundamentally strong companies, so that during the crash you get a good opportunity to average down your portfolio.
As Mr. Warren Buffet said, “Be fearful when others are greedy, and be greedy when others are fearful.” It is another way of saying; When everyone else is dumping stocks in the market, it is the right time to enter and buy shares in the market.
For instance, in March 2020’ Reliance (RIL) made a low of Rs. 870. And, by July 2020’ it was again at Rs 1720. Therefore, have a long-term approach in mind and buy good cash-rich companies when they are available at a discount.
If your investment horizon is more than five years, you should be okay with buying at any price. Learn how to allocate your portfolio stocks. Divide your fund within every sector and most importantly, invest in defensive sectors. They will defend your portfolio from any disruption in the market.