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Right after the event, I felt shocked and depressed. I've been engaging in stocks for about a year now but I've never encountered such a big jump in such a short time. What I'm planning to do is just wait for it to rise again, which I'm not sure when. (Well, who is?)

What should my mindset be?


I understand that there are already lots of questions regarding When should I sell? or Should I set a stop loss? For me, this question is not 100% about how to protect your money, but it's more of In extreme cases like this, how should I mentally prepare myself?

I anticipate that there will be comments/answers like "we can't give advice if we don't know the exact stock in topic" or somewhere along those lines. I want to pre-emptively tackle this and say that this question is not only for my specific current case. I'd prefer answers to be generic for everyone facing the same problem.

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    Comments are not for extended discussion; this conversation has been moved to chat. – JohnFx Mar 8 '15 at 0:49

13 Answers 13

98

You bought the stock at some point in the past. You must have had a reason for this purchase. Has the recent change in price changed the reason you bought the stock?

You must assume your losses are sunk costs. No matter what action you take, you can not recover your losses. Do not attempt to hold the stock in the hopes of regaining value, or sell it to stop losses. Instead approach this event as if this very day, you were given shares of the company's stock at their current market value for free as a gift. In this hypothetical situation, would you hold the shares, or sell them? Use that to judge your options.

Not everyone, myself included, can handle the mental stress of watching share prices change. You can always consider trading index funds instead, which are much less volatile but will provide consistent, albeit, boring returns. This may or may not be you, but it's an option.

Finally, do not keep money in the market you are not prepared to lose. It seems obvious, but if you lost 40% today, you could lose 100% tomorrow.

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    This is solid advice. The price at which you bought the stock is the past. You have to look at the current time and pricing. – reaper_unique Mar 5 '15 at 7:24
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    +1 for "if you lost 40% today, you cold lose 100% tomorrow". Its so damn true. Never forget that every money you invest in stocks is money you can lose in a freaking short time. – NDY Mar 6 '15 at 9:26
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    Hell, if OP really thinks this particular stock is worth holding, it's currently 40% off the price he last bought in at. – C Bauer Mar 6 '15 at 20:55
  • @CBauer, I agree. If I was looking at a stock that had just fallen 40% in 2 days, there is no way I would buy it now, especially if the market as a whole was actually moving up. – user9822 Mar 6 '15 at 21:36
  • Agreed, but if I'd been in Tesla when they almost went bankrupt, I'd probably have bought in a bit more. – C Bauer Mar 6 '15 at 21:59
17

First: do you understand why it dropped? Was it overvalued before, or is this an overreaction to some piece of news about them, or about their industry, or...? Arguably, if you can't answer that, you aren't paying enough attention to have been betting on that individual stock.

Assuming you do understand why this price swing occurred -- or if you're convinced you know better than the folks who sold at that price -- do you believe the stock will recover a significant part of its value any time soon, or at least show a nice rate of growth from where it is now? If so, you might want to hold onto it, risking further losses against the chance of recovering part or all of what is -- at this moment -- only a loss on paper. Basically: if, having just seen it drop, you'd still consider buying it at the new price you should "buy it from yourself" and go on from here. That way at least you aren't doing exactly what you hope to avoid, buying high and selling low. Heck, if you really believe in the stock, you could see this as a buying opportunity...

On the other hand, if you do not believe you would buy it now at its new price, and if you see an alternative which will grow more rapidly, you should take your losses and move your money to that other stock. Or split the difference if you aren't sure which is better but can figure out approximately how unsure you are.

The question is how you move on from here, more than how you got here. What happened happened. What do you think will happen next, and how much are you willing to bet on it?

On the gripping hand: This is part of how the market operates. Risk and potential reward tend to be pretty closely tied to each other. You can reduce risk by diversifying across multiple investments so no one company/sector/market can hurt you too badly --- and almost anyone sane will tell you that you should diversify -- but that means giving up some of the chance for big winnings too. You probably want to be cautious with most of your money and go for the longer odds only with a small portion that you can afford to lose on.

If this is really stressing you out, you may not want to play with individual stocks. Mutual funds have some volatility too, but they're inherently diversified to a greater or lesser extent. They will rarely delight you, but they won't usually slap you this way either.

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    In considering why a stock price dropped, it's also important to consider what that means: it means yesterday someone paid a certain amount, but nobody's willing to pay as much today. It's possible that the person who bought yesterday was a fool and the stock was never worth that much, or that the stock is worth more than today's price even though prospective buyers don't see that. Although stocks' prices should generally reflect their underlying values, it's possible for a stock's price to soar regardless of value if enough fools are willing to pay inflated prices. – supercat Mar 6 '15 at 21:20
9

From some of your previous questions it seems like you trade quite often, so I am assuming you are not a "Buy and Hold" person. If that is the case, then have you got a written Trading Plan? Considering you don't know what to do after a 40% drop, I assume the answer to this is that you don't have a Trading Plan.

Before you enter any trade you should have your exit point for that trade pre-determined, and this should be included in your Trading Plan. You should also include how you pick the shares you buy, do you use fundamental analysis, technical analysis, a combination of the two, a dart board or some kind of advisory service? Then finally and most importantly you should have your position sizing and risk management incorporated into your Plan.

If you are doing all this, and had automatic stop loss orders placed when you entered your buy orders, then you would have been out of the stock well before your loss got to 40%.

If you are looking to hang on and hoping for the stock to recover, remember with a 40% drop, the stock will now need to rise by 67% just for you to break even on the trade. Even if the stock did recover, how long would it take? There is the potential for opportunity loss waiting for this stock to recover, and that might take years. If the stock has fallen by 40% in a short time it is most likely that it will continue to fall in the short term, and if it falls to 50%, then the recovery would need to be 100% just for you to break even.

Leave your emotions out of your trading as much as possible, have a written Trading Plan which incorporates your risk management. A good book to read on the psychology of the markets, position sizing and risk management is "Trade your way to Financial Freedom" by Van Tharp (I actually went to see him talk tonight in Sydney, all the way over from the USA).

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    "If the stock has fallen by 40% in a short time it is most likely that it will continue to fall in the short term" this is contradictory unless you are using some literally secret knowledge about why it is likely to fall that other people holding the stock don't have. – djechlin Mar 7 '15 at 5:19
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    There is no more inherent reason for a falling stock to continue falling than there is for a rising stock to continue rising. Hence my suggestion that the first thing you ask is whether you understand what it's doing.... and if not, whether you did your homework well enough before -- and after. -- selecting this stock. Momentum exists, but if you don't know the forces you can't guess how long before momentum is overcome. – keshlam Mar 7 '15 at 5:36
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    @djechlin - it is simple, look at some charts, some will be going sideways (up and down within an upper and lower range), others will be moving up week after week and month after month (called an uptrend), and others will be moving down week after week and month after month (called a downtrend). Uptrends and downtrends can continue for years sometimes, so if a stock has fallen sharply (most probably due to some bad news or bad financial results) it is likely that it will continue to go down. There might be the odd bear rally from time to time, but the overall direction will be down. – Victor Mar 7 '15 at 7:56
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    @Victor Why did you pick Apple instead of a company that went out of business? Even in your example you assume you're picking a successful enough stock to have this discussion. Index funds never go out of business. – djechlin Mar 7 '15 at 14:22
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    Exactly. You can find examples going both ways from any given starting point. The momentum theory leads to buying high and selling low at least as often as the reverse, unless you have other data... in which case you wind up deciding on the other data. 50% correlation is noise. – keshlam Mar 7 '15 at 19:28
5

Have the reasons you originally purchased the stock changed? Is the company still sound? Does the company have a new competitor? Has the company changed the way they operate?

If the company is the same, except for stock price, why would you change your mind on the company now?

ESPECIALLY if the company has not changed, -- but only other people's PERCEPTION of the company, then your original reasons for buying it are still valid.

In fact, if you are not a day-trader, then this COMPANY JUST WENT ON SALE and you should buy more.

If you are a day trader, then you do care about the herd's perception of value (not true value) and you should sell.

DAY TRADER = SELL

BUY AND HOLD (WITH INTELLIGENT RESEARCH) = BUY MORE

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    +1: Great answer here. One point of elaboration there are many good reasons for a company to drop that much in 1 day that would be strong sell indicators. Major legal troubles, falsified earning reports, head office burned to the ground, etc. Confirmation that market sentiment is based on actual change in underlying value is huge. – Myles Mar 5 '15 at 18:54
  • Company I used to work for falsified their accounts, CEO went to prison, share prince dropped to 5 pence. 1 year later, share price was 72 pence, still way off the pre-fraud peak at £5 but.... I still wish I'd bought when it was 5p and sold at 72p as I knew the old CEO came back to rescue and recover the company :( – gbjbaanb Mar 6 '15 at 12:00
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You shouldn't be picking stocks in the first place.

From New York Magazine, tweeted by Ezra Klein:

New evidence for that reality comes from Goldman Sachs, via Bloomberg News. The investment bank analyzed the holdings of 854 funds with $2.1 trillion in equity positions. It found, first of all, that all those “sophisticated investors” would have been better off stashing their money in basic, hands-off index funds or mutual funds last year — both of them had higher average returns than hedge funds did. The average hedge fund returned 3 percent last year, versus 14 percent for the Standard & Poor’s 500.

Mutual funds do worse than index funds.

Tangentially-related to the question of whether Wall Street types deserve their compensation packages is the yearly phenomenon in which actively managed mutual funds underperform the market. Between 2004 and 2008, 66.21% of domestic funds did worse than the S&P Composite 1500. In 2008, 64.23% underperformed. In other words, if you had a fund manager and his employees bringing their skill and knowledge to bear on your portfolio, you probably lost money as compared to the market as a whole. That's not to say you lost money in all cases. Just in most.

The math is really simple on this one. Stock picking is fun, but undiversified and brings you competing with Wall Streeters with math Ph.Ds. and twenty-thousand-dollars-a-year Bloomberg terminals. What do you know about Apple's new iPhone that they don't?

You should compare your emotional reaction to losing 40% in two days to your reaction to gaining 40% in two days... then compare both of those to losing 6% and gaining 6%, respectively.

Picking stocks is not financially wise. Period.

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    This. Unless there is a non-financial reason you want to own a stock, like enjoying the idea of owning a little bit of Company X, you really, really, really belong in low cost index funds. – Fomite Sep 8 '15 at 7:50
3

Hopefully, before you invested in this stock, you evaluated the company. You looked at the financial information about the company and where the company was headed, and evaluated whether the stock was undervalued or overvalued. Hopefully, you determined that the stock was undervalued at the time you bought it.

The thing to do now is to reevaluate the stock. Do you think the stock is overvalued or undervalued right now? If you didn't own it, would you buy it today? Instead of looking at the past performance of the stock, you want to try to determine which direction the stock will go from today. If you wouldn't buy it today at it's current price, then you should sell.

If you have no idea how to do this evaluation, neither do I. For me, with the investing knowledge I have right now, investing in an individual stock would be way too risky. If you don't know how to evaluate a stock and determine if it is a good buy or not, then you should stay away from individual stocks and instead invest in stock mutual funds, which lower the risk by diversifying over lots of stocks.

2

I haven't seen anyone mention tax considerations and that's why I'm answering this. The rest of my answer is probably covered in the aggregate of other responses.

Here's how I would look at this in a taxable (not an IRA) account:

This could be an opportunity to harvest the tax losses to offset taxable gains this year or in future years. Unless I have compelling reasons to believe that the price will recover by at least (Loss% x ApplicableTaxRate) in the next 31 days then I would take the known - IRS tables - opportunities over the unknown.

Here's what I would consider for all accounts:

Is this the most likely place to earn a good return on my money and is it contributing to a strategy that fits my risk tolerance? You might need to get some emotional distance from the pain to make this determination objectively.

As you consider your trading and investment strategy going forward consider that when it hurts and you have to pull yourself up by the bootstraps to think clearly about your situation, you were most likely trading with too much size for you in that particular position. I'm willing to make exceptions to that rule of thumb, but it's a good way to use the painful losses as a gut check on how your strategy fits your real situation.

P.S. All traders experience individual losses that hurt and find their way to the most suitable strategies for them through these painful experiences.

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    You assume the OP is in the USA, but he is not he is in Australia. Secondly, i don't think tax should be your primary reason to buy or sell any asset. – user9822 Mar 6 '15 at 21:42
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    1) Did my answer say that tax considerations should primary? – Nathan S. Mar 7 '15 at 16:24
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    (2) You really improved my awareness of OP's jurisdiction, so thanks for that. I needed it. Nevertheless, I believe that tax awareness is even more important in Australia. (3) While I agree with that taxes shouldn't be primary, if you're neglecting them for most taxable investors then your model is wrong. – Nathan S. Mar 7 '15 at 16:46
1

Like @chirs, I'm of the opinion that you might want to buy more.

I've done this a couple of times, price dropped a bunch, and I said, heck, I bought some last week, and this week I can get twice as much stock for about the same price.

Brought down my average cost per share, and when the company was taken private, I actually didn't lose money - unlike some other people I know, who only bought at one price, watched the drop, and held on awaiting a recovery (which didn't happen in time before the big money swooped in on it).

But to do this, you need to keep cash reserves (that, like @afforess says, you can afford to lose all of) on hand, awaiting buying opportunities. This, too, is a cost - an opportunity cost.

1

Try to value the stock as is. If you assume it will bounce back, you're currently not thinking clearly. The new price is what it is, and it will go up or down from here.

If you're quite sure that the price will go up, buy, if you're quite sure that the price will go down, sell, as usual.

If you find that you are unable to objectively value the stock, sell it off. By closing the position you will not necessarily get the best possible price. But by removing a stressful distraction you will significantly reduce the risk of making some expensive mistakes in the near future.

0

The mental approach should be that you always knew the risk of gambling and it was extra money that you had (or should have had). Now think that the 'horse' race is not over and in the near future it will pick up pace against the others and be back on track.

0

Don't throw good money after bad. If you bought on the peak of an event like news/earnings hoping for more and ignored its value than you might be doomed.

Determine the stocks value and see it as a buying opportunity if it's still sweet. If not buy more carefully.

Those kinds of moves in that range you must have been involved in micro-small caps like biotechs. Thats where money goes to talk to itself and chew on its arm. You win big by finding an alien chip under your skin to reverse engineer or far more likely just wind up eating yourself. If your not holding inside info or at the higher levels of a pyramid for a pump/dump you really shouldn't let your greed take you there.

I can expect and stomach w/o worry being wrong at my buy time as much as 10-15% and live with it for a year or more because I see I'm buying a quarter for a dime and will continue to buy into it without staking everything though). I bought in heavy when netflix (prior to split) was $50 or so hoping for a quick bounce and it sunk to like 20 something. No I didn't buy more, I felt like I just got my own .com bubble experience. I stopped looking at it,helpless to do anything other than eat a huge loss I adopted an out of sight out of mind thinking. I no longer wished to be in it, I felt like an ass for getting myself into it, it did NOT look good at the time and I risked a huge amount of capital for what I felt wrongly was a nice quick trade to make some thousands off. Checked it one day, must have wanted to hurt myself, and it was near $300 a share. My extreme loss had turned into something wonderful. A big tax bomb. Netflix eventually split and rose even more meteorically. I held on and only exited a while back and my worst mistake became my best success. Yet still, you trade like that, on unsound things, don't rely on getting the winning ticket because they are few and all others are losers. If your in for a penny you need to be in for the pound and help yourself immensely by sticking to sound stocks and currencies. You trade on news you may find yourself in Zimbabwe dollars with Enron stock. Bad footing, no matter the news or excitement is bad footing.

0

If you own the stock today, it doesn't matter what it traded for yesterday. If XYZ is trading for $40 and you own it, ask yourself if it's worth buying today for $40. If it isn't, you may want to consider selling it and buying something that is worth $40.

-5

Did you read Soichiro Honda's biography? He is the founder of Honda Motor.

His plant was destroyed by an earthquake, and then he proceeded to build another factory which, as World War II broke out, was lost again with his money, and many of his friends', but he started again.

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