Assuming you have conducted due diligence assessing the investment merit of a company. All things seem good – growing revenue, earnings, low debt, strong fundamentals, management hold large stakes etc. So it passes your investment screen.
The Following scenarios might occur.
Share Price Shot up After Your Analysis
Before you have bought it.
I am sure many have experienced this before. You have done your homework, you were confident in the company’s prospect, outlook is good, market is there to seize.
Then you got pre-occupied with other life matters. You got busy. And maybe two weeks later, share price shot up due to huge order win, or some analyst’ initiation report, or a privatisation offer. And the worst thing is these events were all partially expected in your analysis.
But you have not boarded the boat!
So now you are in a dilemma and not sure whether at the current price 25% higher, you should still enter.
Sold Too Early
Let’s say you have bought the stock. You held on to it and share price increased 40%. You are happy with the profit, and based on your homework you estimated that this is the fair value. So you went ahead to sell the share and pocket the 40% profit happily.
But shortly after you sold the share price continued rising another 50%. So instead of riding the share all the way, you have missed out on an almost-one-bagger stock.
Catch a Falling Knife
Or another case is that the share price has been in an uptrend past two years, regularly breaking new 52 week high. So you cant actually bring yourself to buy it due to the perceived expensive share, and fear that its trend might reverse.
So due to whatever reasons, the share price has came down 15% from its recent high. Naturally you would think this is much better entry price relative to earlier period, so you press the buy button and there you have a stake in this company.
But share price keeps dropping after that. In the short term, this sort of price movement and momentum tends to follow through so there is still much room for further drop.
Essentially, you have caught a falling knife.
How Should You Deal with These Mistakes?
Well no investors are perfect. Everyone makes mistakes and these are common frustration that each of us encounter.
In terms of worst error, I would say catching a falling knife deal the worst damage. Price shot up before you bought can be frustrating, but at least you don’t lose anything and things are status quo. Selling too early, is the least of three evil, as you would have pocketed at least a substantial gain.
If one caught a falling knife, you can decide to cut loss if it has touched your stop loss price. This is the best way to preserve capital and prevent the loss from snowballing into damage beyond repair, which would be disastrous. But if you were very confident about its business based on your in depth research, you can hold and wait for break-even.
Average down? It’s a tricky move and I would not recommend it.
Price shot up before you bought it? My general advice is do not chase but wait for pull back. You may check the share historical movement using technical analysis for example uptrend channel, strong support level, or previous pull back percentage, and buy at the relevant price level.
Anyway, do not be too frustrated about it rocketing price before you bought it. There are many companies in the market and stock exchange is always open. Missed this opportunity? Look for the next one then.
What about selling too early? Firstly, look at the positive side and celebrate your 40% returns, instead of feeling upset about the ‘missed’ profit. After all, you have already pocketed handsome gains. Leave some money on the table for next investors. Secondly, perhaps not to be too sticky about target price and leave some wriggle room to observe further how high it can go. You can implement a trailing stop loss in this case to capture maximum gain possible and take profit before full trend reversal kicks in.
But the more important matter is to accept these mistakes as part and parcel of your investing journey. Consistently refine your investing strategy, system and rules, and with more experience in the market, you should find yourself encountering these scenarios less and less over time.
So if you would like to learn more about investing rules that reduce the probability of these scenarios happening, it will be covered in my upcoming talk on 25 Aug. I will aksi share with you solid investing knowledge distilled from experience, dotted with personal stories, and practical tips on selecting strong stocks, REITs, bonds etc. No fluff, no sales talk, one content-packed session.
Do sign up for the free seminar here.