Getting the most out of Panic Selling

In a situation where the price of stocks start declining at a rapid speed along with high volume sell off leads to panic selling. This mostly happens when investors are forced to re-examine the intrinsic value of the stock, or when the price of the stock is forced down enough to cause persisting stop losses by short term traders.

The occurrence of such a process provides big opportunity to start long term positions for the bottom- fishers especially when the factor behind the occurrence is speculative or non material in nature. Panic selling has been discussed below along with a model provided to judge the right time to take the long position, after panic selling takes place.

Stages of Panic Selling

There are several phases involved in a panic selling process. In the first phase the price of the stock is observed to decline rapidly on high volumes because of several factors. The second phase observes sudden high volumes where sellers and buyers try to take control of the trend.  Low follow up volume trend is taken by the winner. If no change is observed in the second phase then there is a possibility of the occurrence of a substantial reversal (short or long term) in another high volume point which generally takes place in the third phase. Until the establishment of a trend of long term backed by confirmation of fundamental or technical factors, the same process continues.

How could one actually determine that a floor price has been attained?

In order to determine exactly when a price floor has been attained, the Exhausted Selling Model was developed. It is usually carried out by using the following combination of turnaround, volume and trend indicators:

• Volumes
• Trendlines

• Chart Patterns
• Moving Averages

ESM model could actually be very handy for the investors who wish to cash in and make the most out of panic selling situations. However some strict things that one should look for while adopting the ESM model are:

1. For an ESM model to be applied there should be a steep and rapid decline of the prices of a stock along with high volumes.
2. You must look for a spike in volumes which will take place, giving rise to a new low and seem like reversing the trend.
3. There would be an occurrence of a higher low wave.
4. The panic selling should see an occurrence of a break in the influential downward trend line.
5. In terms of technical analysis the moving averages of the 40 or/and 50 day must be broken whereby both these levels must then be hold and retested.

Other moving averages that connect lows or highs may also be used. The trend break of bigger moving average is a lot more indicative rather than smaller moving average breaks.

Panic selling is usually driven by the herd theory wherein the traders and investors seeing high volumes of selling being done and observing people exiting their positions creates insecurity among them. Citing that the best means to be safe from making huge losses people end up selling their stocks at lower levels in order to reduce their losses. Smart traders and investors usually cash in at these situations as it presents a good opportunity to enter the market and make some gains or step into fresh positions. Good buying opportunities are created by panic selling for investors and traders who are well informed. After the selling is finished, people who are aware of it can benefit from turnaround/retracements that usually occur after the selling is finished.

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Abhishek Gupta is working as a Fund Administrator (Hedge Funds) with the HSBC Bank (Kolkata) for over a year. He pursued Bachelors in Commerce from Calcutta University and completed postgraduate as MBA (Finance) from Calcutta Business School.