Stock prices go up and they go down. Since 2008, stock prices have fluctuated (sometimes wildly) and investors don’t always know what to do.
The expert advice out there is mixed: Some wisdom says “Cut your losers and let your winners soar”, meaning that you should only hold stocks that are generally going up. Other wisdom says that the best time to invest is when other people are running scared from a stock, meaning that you want stocks that other people see as losers (i.e. the stocks that are down).
So what should you do if the prices of the stocks in your portfolio drop? Cut them? Hold them? Buy more?
Here’s what I think…
Assuming that you did sufficient due diligence when you first bought the stock, then identifying the changes in the market’s valuation of the stock as well as the overall market sentiment can reveal what you should do.
- Dig into the news about the stock. Ask yourself this question: “Why has the market changed its mind about the value of this stock?” Figure out what has changed: What news item or piece of information has altered the trajectory of the price?
- Take a step back and look at the wider picture — the industry and the market as a whole. What’s happening at the bigger level that might have an influence on this stock?
Then use a chart like this as a guide to know what to do with the information you’ve discovered above…
- If information about the company of the underlying stock has remained the same and if the market is unchanged (upper left quadrant), then this price drop could be something else, such a temporary sell-off (i.e. for tax loss purposes or institutional investor portfolio rebalancing). In those cases, I prefer to double-down and buy more.
- If the information about the company of the underlying stock has changed but the market remains unchanged (upper right quadrant), then I need to take a closer look at the stock — to revisit whether I think the fundamentals are still true and to sell if they are no longer true.
- If the company hasn’t changed but the market has (lower left quadrant), then I’ll revisit the stock but in general have tended to hold my stocks during this time. Market corrections are cyclical and I’m not going to worry about them too much.
- If the company has changed and the market has changed (lower right quadrant), then it is very likely time to sell because my entire profit thesis when I first bought the stock is no longer relevant.
This chart isn’t ever going to be perfect for everyone — we each have different investing goals and time horizons — but when you open up your portfolio and see that one or more of your stocks have fallen, a tool like this is a useful way to take a step back and apply a layer of analysis to the situation so that you don’t simply sell in an uneducated knee-jerk reaction.