Managing the ups and downs of the stock market

Financial markets
Market news
Market contingencies

Stock investing is never an easy way of wealth enhancement – there is no shortcut and no guarantee of gains. The fluctuation of the market and individual share prices are affected by a wide range of factors. A proper investment attitude can help you manage the risks during the ups and downs of the market. Going back to the basics – ie always do your homework before making any investment decisions, beware of the risks, and don’t take a gambling attitude – are golden rules.

Stop, pause and reflect if the following scenarios are relevant for you:

1. Should I buy stocks based on market news/rumours, in particular the mid/small-caps which may offer good opportunities for quick gains?

Though everyone wants to make profits, the reality is that the higher the potential gain, the higher the potential risk. This is true for all investment products and in all market circumstances.

Market news on individual stocks or potential favourable government policies to specific sectors that may stimulate stock prices, can turn out to be rumours. Even if the news is factual, such information is subject to different interpretations by different investors, in particular under volatile market conditions. Share prices may correct sharply and quickly at any time. So market news-driven investment decisions could be very speculative and could involve high risks.

Even in a bullish market, share prices will fluctuate and there will be corrections along the way. It is just a matter of time. Also, it is never easy to catch the right timing for market entry or exit. You may incur significant loss if the share prices suddenly plunge when the upward trend in the market turns around.

Share prices of individual stocks can be very volatile, in particular the small-caps and stocks with shareholding highly concentrated in a small number of shareholders* (in this scenario, the share price could fluctuate substantially even with a small number of shares traded). Think carefully if you have the ability to withstand the potential losses. Also as a rule of thumb, you should understand the fundamentals of the company you have in mind and the risks of what you are investing in. Stay cautious and don’t invest in something that makes you sleepless at night. Do not follow blindly the tips from market commentators.

*Investors can refer to the SFC website for the list of companies with high concentration of shareholding.

2. I am offered a loan at a preferential interest rate from a finance company and can use the money for investing. Should I borrow the money to buy stocks? How much risk will there be?

You may find it easy to get money via borrowing (eg cash advance from credit cards, personal loans or even mortgage loans etc) to increase available funds for purchasing stocks, but you should be aware of the consequences of the potential downside of this scenario.

Consider the following case:

James has a stable job with a monthly income of HK$20,000. His friend told him that the share price of Company X was predicted to go up due to its good business prospects reported in the media. A few days later, James found that the share price of Company X did increase by almost 20%. He then decided to borrow HK$100,000 to buy Company X stock, aiming to sell the stock once the share price went up by another 10%. He believed this was a smart investment decision as the interest rate of the loan was low compared to his expected quick return of trading Company X stock. However, it turned out that the share price plummeted immediately after James bought the stock. Even worse, the trading of the stock was suspended and Company X was subject to regulatory investigation.

You may consider this just an unfortunate or rare case. But borrowing money to bet on short-term gain in the stock market is very risky. If the market moves down or due to other reasons, the share price of the stock falls, you will suffer loss. In addition, you have to pay interest and other fees related to the loan. And in the worst case, if the stock was suspended from trading, you could not sell the stock until it resumed trading. Your investment is locked in but you still have to repay the loan and interest. You might then incur multiple losses.

3. I can easily open a margin account with my brokerage firm. Should I make use of margin financing to invest in stocks?

Margin trading is a common way of borrowing to invest. But beware it can magnify your gain as well as the loss. In this scenario, investors use their existing stocks as collateral in their margin account, to borrow money from the brokerage firm to buy more stocks. If the stock prices drop to a level that the value of the collateral in your account is not enough to cover your margin position, you will have to add more money to your account or else your stock collateral will be sold by the brokerage firm (ie the margin call**) to make up for the shortfall. In a highly fluctuating market, it is very important for you to always monitor closely your margin position and be prepared for the margin calls. In the worst case, you would lose more than your original capital.

So always consider carefully your financial situation and the high risks involved in leveraged investing. Know more about margin trading.

**The brokerage firm may not be obliged to make a margin call or otherwise tell you that the value of the securities held on your account have fallen below the specified lending ratio. Your brokerage may sell your securities at any time without consulting you.

4. My friends said trading CBBC can make huge gains within a short period of time. Should I try to invest in CBBC?

Structured and derivative products such as CBBC (ie callable bull/bear contracts), warrants, futures, options or equity-linked investments are complicated instruments. Due to the leveraging effect, a small change in the price of the underlying assets can result in significant price movement of the structured/derivative product. While some of them (eg options and futures) can be used as a hedging tool to manage risk, these products can also be a high risk instrument if they are used for trading purposes. In general, structured/derivative products are only for sophisticated investors who understand the product and can afford the potential losses.

Equip yourself with useful investment techniques:

1. Diversification:

Avoid putting all your money into a single investment or a single type of investment (eg stocks or properties). An investment portfolio with diversified asset allocation based on your investment objective, time horizon and risk tolerance can reduce risk and help you achieve your investment objective over the medium to long term.

Diversification can be achieved through holding different classes of assets such as stocks, bonds, funds, insurance saving plan and properties in your portfolio. You can also adopt a diversification strategy within one asset class, such as stocks. For example, compared to investing in a single stock, an exchange-traded fund which invests in a basket of stocks can help to achieve diversification in the stock market. Besides, the performance of different sectors may not be correlated closely to one another, eg the utility sector may not be impacted by a rise in interest rates as much as the financial sector. Investing in different sectors can therefore be a way of spreading your investment risk.

2. Stop loss strategy for stocks

Make use of stop loss strategy to protect your investments from possible significant losses. You can limit your losses by placing a stop loss order with a broker to sell a stock if its price drops to a certain level (ie the stop loss price specified by you). Alternatively, you can set a predetermined percentage, such as 15% below the purchase price, as the cut loss level. The stop loss strategy is a risk management tool that helps you manage the downside risk.

3. Dollar cost averaging

You could also consider dollar cost averaging (DCA) to smooth out short-term market fluctuations. DCA works best for long term regular investment (like MPF) but the principle can still apply in other scenarios. For example, if you plan to invest a lump sum amount in a stock (say HK$150,000), you can spread the purchase over three stages, eg invest HK$50,000 on any designated date in three consecutive months. This technique reduces the effects of short-term market fluctuations on investments by averaging out the costs of your investment over time.

Last but not least, you should always know your investment objectives, horizon, risk tolerance, projected financial resources and fully understand an investment product before making a purchase decision.