Trading Note #4: The Psychology of a Tanking Stock

The past 2 weeks have really been painful, instructive, and thankfully quick.

The short story:
Bought in when it just started plunging, sold it when it bottomed. And later during the day that I sold, the stock shot back up and over my original purchase price =(. Things can't get worse much than that =)

The long story:
The stock has been pretty stable around $10.00 – $10.25 for bout a week. Then one day, a neutral piece of news (what I peceived to be) came out. The next trading day, the stock shot up to bout $10.40 for pretty much the rest of the day.

Mistake #1: Thinking that the stock will be stablising at a higher trading range, I wanted to go long the next day at the low-end of the intraday fluctuations.

So the following that I bought in at $10.28, at the same time making Mistake #2: Not buying in at the intraday low (see Trading Note #3). Mistake #1 was a logical/strategic mistake, and Mistake #2 was an execution mistake.

What happened for 4 consecutive trading days after that was that the stock tanked, with the trading range steadily dropping till $9.93 – $10.00. During that 4 days, I was trying everyday to liquidate my holdings and cut my losses, but the greed of earning a few points and minimising my losses prevented the sale every day.

Mistake #3: Being too freakin greedy! And not having decided on a "minimum acceptable selling point" before the market opens.

Finally, when it got down to $9.93, my over-riding thought was "I NEED to get rid of my holdings NOW, regardless of price!". The loss was becoming too significant with potential for even greater loss. Hence I sold all my stake at $9.97.

Mistake #4: Selling without thinking! (see analysis below)

Following my sale, as though Mr Market knew that it had finally got me =), the price just steadily climbed to $10.46, completing the manoeuvre by twisting the blade that was stuck in me for the past 4 days.

Learning Points:

I think there are 3 stages of "development":

  1. The first is when you keeping hanging on to your losers, not wanting to realise the loss, hoping for the stock to recover and tying up that sum of money which could be generating better returns elsewhere.
  2. The second is when you cut your losses promptly, perhaps with a threshold (e.g. 2% maximum loss).
  3. The third is when you combine that with a fundamental view of the stock. If you assume that you currently _do not_ hold any stock of that company, would you want to buy it at that particular price? If the answer is yes, then you should hang on.

I initially thought that I understood point 3. But it turned out that holding a plunging stock clouded my judgement and resulted in a strong urge to just "end the losses". Hence the importance of making that judgement call with the assumption that you do not have any position.


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