Stock market slump: You'll fall into a bear trap if you panic and sell shares

The market has reached a point in its descent where investors are inverting the classic advice to sell high, buy low. Sit tight in a storm, writes Simon Read

In a bear market, share sales bring down share prices and encourage more investors to sell up, leading to a self-perpetuating downward spiral (AFP/Getty Images)

There has been a lot of noise this week about the stock market falling into bear territory. Amid the continued share sell-off, Wednesday's closing price for the FTSE 100 marked a fall of more than 20 per cent since the index hit its all-time high of 7,122 points last April. And that means it officially became a bear market.

What is a bear market? It is defined loosely as one where share prices have fallen so far, it encourages more selling. In the worst cases, investors panic and try to cut their losses by selling more and more. The market can thus become set on a self-perpetuating downward spiral.

But panic is never a basis for making an investment decision. Indeed, when some people are losing their heads, an opportunity arises for othersto pick up great deals.

It goes right back to the investment basics of buying low and selling high. Those investors who shed shares in a bear market tend to sell low after they've bought high – and consequently suffer potentially huge losses. But those who can afford to keep their heads should ride out the lows and sit tight for an eventual recovery.

That may be months – or even years – away. Again, however, sensible investors who are in a position to do so take a long-term view. Making decisions on a short-term basis amid market volatility is a recipe for potential financial disaster.

"Bear markets can be frightening for investors. However, they are only an issue if you have to realise your investments at the bottom of that bear market," said Richard Stone, chief executive of The Share Centre. Otherwise, he added, "bear markets can provide buying opportunities.

"History would suggest the recovery.. will be substantially longer than the downturn and will deliver returns in excess of the paper losses."

So how should you react? The first thing to do is understand why we're here. In essence, the current bear market has developed as a result of a wide-ranging variety of financial and economic problems. There are continuing fears over China, both because of its stock market plunge, slower growth and the weakness of its currency. Then, of course, there's the falling oil price. That reached a near 13-year low this week, ploughing below $30 a barrel. To put that into context, it almost reached $150 in 2008, and as recently as June 2014 it stood at $112.

There could be worse to come for oil but experts reckon the market has already built more bad news into the price.

As such, it's time for reflection, rather than action, according to Mark Burgess, global head of equities at Columbia Threadneedle Investments. He said: "Investors should not panic but accept that 2016 will be a low-growth, low-return world, with corporate margins pressured by weak end demand and overcapacity in a number of industries."

Longer-term investors know that what can feel like an emergency in the short term may not hold as much significance some years down the line, Mr Burgess pointed out. "So a focus on old-school investing values makes particular sense in such a volatile world".

That view is echoed by Adrian Lowcock, head of investing at Axa Wealth, who pointed out that panic causes investors to act irrationally and increase volatility in the short term. He said: "It is important to remain focused on fundamentals and your personal goals, such as retirement."

Meanwhile Nigel Green, chief executive of the financial adviser deVere Group, recommends seeking out the buying opportunities that are now being presented. "The sell-off is creating good value in some high-quality companies," he said. "Opportunity knocks in such stocks as the underlying value remains and the prices are attractive."

Action? it's time to maximise tax advantages

Rebecca O'Keefe at Interactive Investor, believes we should focus on tax-saving opportunities.

"This is the time of the year when investors manage their finances and start to take advantage of tax -efficient products," Ms O'Keefe explained.

"Even if you are fearful of where the equity market might go from here, securing your Isa allowance or making a contribution to your pension is a sensible strategy and allows you to take advantage of any tax benefits without having to commit to taking any risk.

"Pension investors, in particular, need to make sure they are not put off contributing to their pension by the current market turmoil, as higher-rate taxpayers should actively be looking to take advantage of the current rates of tax relief available now – before they potentially disappear in the forthcoming Budget.

"Indeed brave investors may actually benefit twice by looking to top up their pension now – securing higher- rate tax relief on the one hand and potentially benefiting from future share price appreciation when the markets do turn around from their current low levels."