Why the market falls faster than it rises?

by Manshu on September 26, 2006

in Articles

 

Almost everyone who has been in the market must have noticed that shares fall faster than they rise.  This article looks at a couple of reasons because of which this happens. 

One reason why this happens is because of traders buying shares on margin money. This happens as follows. Suppose you have shares worth Rs. 1 lakh, on these shares your broker will allow you to take positions of say up to Rs. 40000. What this simply means is that you can buy and sell shares worth Rs.40000 without actually having to cough up this amount. This is called playing on margin money. In the above example the margin is 40%, which means that you can play up to 40% of the shares that you own. Every time the margin decreases below 40% you have to either square off the position or you have to keep extra cash with your broker. Now assume that you have also entered into such a trade where you had shares of say HLL worth Rs.1 lakh and you have bought shares of Infosys for Rs.40000 with the margin hoping to sell them off later in the day and make a quick buck. Unfortunately for you however the market falls and the value of HLL now remains only Rs.90000 whereas you have bought Infosys worth Rs.40000. To maintain the margin of 40% your broker calls you to pay up additional margin money (called margin call in market parlance). You decide that its not worth it and sell the Infosys that you have, further creating downward pressure and lowering the price of Infosys. If you look at the bigger picture and see the market as a whole there certainly will be another person who was holding Infosys worth Rs. 1 lakh and HLL worth Rs.4000, because of your decision this person would need to sell his HLL now. This is a vicious cycle in which many traders will now get trapped and what started off as a correction would result in a big fall. This is one of the prime factors why markets fall off sharply in a single day, the fall being anywhere close to 300 to 800 points on the BSE. 

Another reason why the market falls rather sharply is what is known as “Panic Selling”. What this means is that small and new investors in the market see that the market is falling and they think that there is no end to the fall. Often these investors enter the market with the lure to make big money and know little about what companies they are buying and have little confidence in their investment decisions. Such investors tend to sell all of their holdings in such falls and bail out of the markets. In the process they tend to drive the prices of the shares that they hold further down and end up pushing the prices abysmally low. 

The above two reasons are quite common and can be witnessed in every big fall that the market has. Its for you to understand these reasons and the next time you enter a trade be aware of such reasons and play the market carefully. Anyone who has been in the market will tell you that it is almost impossible to avoid such losses. So maybe you will lose money on such transactions as well. Considering the way the market has risen these days it is probable that the situation confronts you in the near future. You must not completely shun away from the market after such a situation but must understand the reasons, learn from them and not repeat the mistake. 

{ 1 comment… read it below or add one }

Jojo Joson December 20, 2011 at 3:30 pm

“Day Trading” is one of the prime causes. I think a better term to use is “Day Gambling” rather than trading 😉

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