We have been seeing some solid reaction in small cap stocks over the last few trading sessions. In some cases the correction in stocks has been as much as 70 per cent.

For the last month or so, we are seeing some dramatic selling in these stocks. Some of these stocks were overvalued and were commanding hefty price to earnings multiple.

In October last year, the Securities and Exchange of Board of India (SEBI) issued a guideline asking mutual funds to group their equity schemes under large, mid and small caps based on market capitalisation of the stocks the scheme has invested.

So, if a designated scheme is under large cap, it should have a minimum of 80 per cent invested in large caps. These means, if a particular scheme was holding many small cap stocks, it would have to to align the same to the SEBI directive. This could probably be what is leading to some selling pressure in these stocks.
Having said so, it is important to note that there are other reasons to avoid investing in small and mid cap stocks.

One of the prime reasons is that these stocks tend to be more volatile and at the moment, markets are expected to trend down. Worries over rising crude prices, falling rupee and the possibility of a rise in interest rates, could leave the markets worried.

Small cap stocks tend to fall faster than the overall markets. Hence, it would be advisable to stay away from these stocks, until the markets stabilize. If at all there is a desire to invest in these shares, one can consider investing in quality stocks that are debt free and have got a good robust business model.

Indian markets have risen a good deal from their lows of March 2018. In fact, they are up a good 6 per cent from the March lows. Hence, it would be advisable to just stay away from small cap stocks at the moment.