In this article we’re going to look at the most psychological side of stock market investing. It usually comes up when, technical analysis aside, we’ve invested in a stock and it doesn’t behave as we expected when we bought it. At that point a question arises… should you sell the stock or hold on to it?
In this situation, investors can only act in three ways, and we can’t say that one decision is better than another.
If we invest in a stock that starts to fall in value, we can only act in one of the following ways:
1. Sell quickly.
Here, the driving force is fear. We know that if we hold on to a falling stock we could suffer bigger losses, especially knowing that other investors will feel the same fear and will also decide to sell their shares, pushing the price down even further.
2. Hold the stock.
Here we rely on patience. We know the stock market is constantly moving and that a stock may lose value but stabilise again within weeks, months or years. In other cases, an investor tends to hold the stock out of sheer pride, unwilling to admit a loss, since you haven’t lost any money until you actually sell the shares at a loss.
3. Hold and buy more shares.
Other investors, far from worrying that a stock is falling, buy more shares at an even lower price than when they first bought. That way, trusting that the stock will return to its previous level, not only will they have avoided losses, they will have considerably increased their gains. The factor at play here may be ambition (which isn’t a bad thing).
See also: Warren Buffett’s three habits that probably explain his success
So which of these three strategies is the right one?
As we said at the beginning, none of these three strategies is right or wrong in itself, because which one we should apply depends on the stock.
To apply the right investment strategy, we need to analyse the stock, the reason its share price is falling (is it the market as a whole or just this company?), the company’s plans for the future, its expansion projects and any new strategic agreements.
We need to estimate how long we expect the stock to take to rise again, because if it’s too long, it may be better to sell the shares even at a loss rather than leave your capital stuck.
We should also work out whether the dividends we would collect while the stock is stagnant make it worth holding.
Then again, the fall may be caused by a one-off event, or it may be an early warning of a serious problem at the company that could end in bankruptcy. Having analysed these two points, in the first case the ideal strategy would be number 3, and in the second, without a doubt, number 1.
To this day, I admit that the investment strategy that has worked best for me has been number 3. Call it luck, since, blinded by pride, I have sometimes refused to sell at a loss.
Further reading
- What Arthur Rock looks at before investing in a company
- Warren Buffett’s speech in 9 videos
- Stock market investing made easy, part 1
Featured image: Associated Press, Public domain, via Wikimedia Commons.
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