Market Crash – Opportunity or Threat

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I am sure most of you would have seen or heard about yesterday’s (24-Dec-2022) stock market fall wherein the large cap index fell by around 1.6%, but the mid and small cap index fell by 3.4% and 4.1%.

Primary reason for this fall is the fear induced by the new wave of COVID outbreak in China and the fear of this being spread outside of China. This resulted in the first wave of sell off in the market, but the second wave of sell off actually came on account of the margin calls which the broker triggered for the future and option (Derivative) traders.

Let’s try and understand what margins are for derivative trades. Let me try to explain this with an example. While trading in the derivative markets, traders can buy stocks worth 10 lakhs by paying just 10% (Margins differs for each stock in derivatives segment) of the stock value and this is know as margin and traders are suppose to maintain this 10% margin always.

When the stock falls drastically and the stock value falls drastically (which we witnessed yesterday morning), brokers would ask the traders to add more money to their trading account to keep the margin of 10%. However, not all traders would have additional surplus money to maintain this 10% margin and they will reduce their position by selling their position.

When this happens the basics of economics comes to play i.e., principle of demand and supply. When there is high supply and low demand, naturally price of the stock goes down. This is what we witnessed in the second half of yesterday market.

If the above explanation is too complex for you to understand, just remember that “Correction is Temporary and Growth is Permanent”. We have been through the worst during the 1st and 2nd wave of COVID and most of India’s population is vaccinated and we would not face extreme situations. As Warren Buffet says “Be fearful when others are greedy and be greedy when others are fearful”. Use cash available which you don’t need for at least 3-4 years to buy at these levels which will be rewarding in future.

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