Thursday, 22 November 2012

When to buck the trend and ignore the share market

Often times as an investor, especially in listed securities, you will find an investment 'going bad'.  The market will has significantly against you and the temptation is to cut your losses and get out.  This post will be about when to hold your nerve and what you should be telling yourself when your are doing that.

I have posted before about how one of the hardest thing to do as an investor is to sell shares when they have increased in price significantly or very suddenly because greed takes over.  This is the converse case - it is about how it is hard to hold onto you shares when fear takes over.

However I should stress from the start that you should not always hold onto your shares.  There ARE times when you should cut your losses and get out.  There are, however, a very specific set of circumstances in which you should ignore the market and buck the trend

What are the specific circumstances where you should ignore the market?

For you to ignore what is going on in the market, in your own mind you should be very clear about certain things:

  1. Is your valuation of the company up to date and do you believe in it?
    • This means you should have included ALL relevant information that has been released and you need to be comfortable that your valuation is as accurate as it can be
    • If you think that you are right and the market is wrong - this is where you can make real profits
  2. What is causing the share price drop and is this relevant?
    • Share prices fluctuate quite a bit and sometimes they do so for valid reasons (e.g. the company is decreasing in profitability, there is a new, better competitor, they have too much debt) however sometimes it has nothing to do with the company itself (e.g. a company that doesn't have any exposure to Europe falls on concerns about Greek debt)
    • If it is relevant news (or even rumours) then you should be putting these into your valuations as discussed in point 1.  Your valuation is not a static document - it should constantly be updated
  3. What DON'T you know?
    • The hardest thing about being an outsider investing in a company is that you will never know everything
    • You always need to consider therefore what may or may not be happening that you do not know
Assuming your valuation is up to date, the factors causing the share price to drop are irrelevant or temporary and you have accounted for those things you don't THEN DON'T SELL

If you have done everything that you can and you trust your valuation and you understand what is moving the share price then you should have the confidence in your own investment analysis to hold out against the market.

The thing about investing is that you have to be able to ignore what is happening day to day with your stock investments.  They will go up and down and as long as you are tracking the fundamentals and they still look good to you then you should hold out until your valuation not the market tells you to sell  

In these circumstances I have often seen investors double up their bets and take advantage of the lower prices.  I am typically not one of those investors.  If I still trust my original investment then I stick with that amount.

Note that there is always the risk that you are wrong.  There is the risk that there is something that you didn't know that comes and bites you and unfortunately there is nothing you can do about this other than to keep a very close eye on the investments that you do have - especially those that seem under pressure - and constantly be trying to work out what is driving the share price.

A (current) personal example

I thought I would include a quick example that was currently affecting me.  Recently I mentioned that I bought into (in quite a large way) the FKP rights offer.  In fact I was very happy when I got allocated much more than I was expecting

Because I have hold periods associated with any stock that I buy, I have been unable to sell these and the stock has dipped well below my average buying price (and the offer price).  I have more than I am usually comfortable with invested in this particular stock.  

The reason I am holding onto it is as follows (please do not go out and buy this stock because I am saying I think it's good - I'm not giving investment advice - just describing the principle):
  1. I am comfortable with my valuation of the stock and this has not changed as the stock price has been falling
  2. I think I know why the price has fallen so aggressively - I think the underwriters are selling the stock they got issued when FKP screwed their retail shareholders (I hope they are making a loss)
  3. I think there are things I don't know - but I have allowed for those specific items in my valuation
I'll provide an update on how this goes but hopefully the price recovers around the time I want to sell it so I can reduce my exposure a little bit.

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