Making sensible decisions whilst we're anxious and emotional is a challenge. In fact, I'd say this is the challenge in investing.
"Many investors are making these kinds of mistakes right now."
With the ASX down a very heavy 4.1 per cent on Monday, losing more than $60 billion, many investors are making these kinds of mistakes right now.
That's understandable. But it's also the reason why most investors don't beat the market. They react poorly in stressful times like this, lacking the courage to buy when trouble hits also but sometimes bailing out of the market entirely.
So, how should you deal with rapidly falling share prices?
Very few stocks swim alone. Whether markets rise or fall, most will be dragged along in the current. We should try to accept this, separating the general from the particular.
When a stock is worth buying it should be because it is cheap, that it features a margin of safety and will deliver attractive long term returns. If that's the case with the stocks you own, all things being equal, falling markets should be cause for enthusiasm rather than concern.
If you are going to worry about a stock that has fallen, do so with regard to its particular business, not the general state of the market.
Price falls after you buy a stock are inevitable. Investors unable to accept this fact are effectively saying it's possible to pick the point at which a share price will hit bottom, which it isn't.
Avoid the self-referential wall of mirrors which share price fluctuations exist in and let the difference between the price of a stock and the value at which it trades be your guide.
Once you accept you can't pick the bottom, logic suggests that stocks can and will fall in price once you've purchased them. It happens and it's unpleasant. But if your original analysis was correct, why worry about cheaper prices?
Whilst a falling share price after purchase doesn't necessarily make your decision a poor one, it doesn't make it right, either.
If investing is a science, it is more akin to economics than maths or physics. Facts change, senior managers leave and new competitors spring up. A changing environment makes mistakes inevitable; don't beat yourself up over them.
No investor has become wealthy without first losing substantial sums of money. The difference between those that succeed and those that fail is not in the mistakes they make but what each takes from them. You will be wrong. Accept it, learn from the experience and move on.
Dyed-in-the-wool value investors rely on their contrary instincts, backed by deep, sturdy analysis. When they experience a falling share price, which might call in to question their argument to buy, they tend to disregard it.
Less experienced investors run the risk of falling victim to confirmation bias, seeing further price falls as confirmation of their concerns.
This is when the mistake is made. Each time you look at a stock do so with a fresh pair of eyes that assesses not just your argument to buy but the seller's argument, too. If you find the seller's argument more persuasive and the evidence against you, sell.
The opposite situation is easier to deal with. If after examining the sell case the buy case still stacks up and the share price has fallen substantially, buy more (with a caveat).
Knowing that share prices can be volatile should impact how you build a position in a stock.
Making a number of purchases over time means you can take advantage of further price weakness, averaging down your entry price. Whilst it's exciting to finally buy a stock that's been on your shopping list, don't dive in.
John Addis is the founder of Intelligent Investor Share Advisor. This article contains general investment advice only (under AFSL 282288). Authorised by James Carlisle.
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