Just wanted to record a typical “cycle” when a position drops:
- First, you would think – it only dropped for one day today… yesterday it was doing great.. it can easily jump back up to yesterday’s levels the next day.. so let’s not do anything now… wait it out and see what happens… what if you sell it and the next day it goes back up? …. its ok it just dropped a little that’s all… relax..
- Next day, it drops further. Now you think – damn, i should have sold yesterday…. i knew it, i should have sold when it was at a high…. now if i sell i’m gonna lose a lot…. so i shouldn’t sell now… its ok… i’ll just buy more when it drops further… i’ll leave this position now… after i average down and the price recovers, i’ll make it all back and more… yes just ignore it… wait for the price to tank before buying in again…
- Again the next day it drops further. Now you think – now i definitely cannot sell, i’m losing a ton of money… yeah can’t sell now…. should i buy?…. what if it drops further?… how far will it drop?… maybe i’ll wait first… see what happens….. don’t go in now…. or i set a very low limit order (which doesn’t get hit)
- Now it can play out two ways:
- The stock really tanks. You start to buy in, and at one point you think that this is it, you buy in a large position, stock drops further, you ran out of cash, and you’re out of the game and left holding the paper hoping it break even.
- The stock bounces back up. Now you think – damn, i should have bought in with all my cash…. it was at a really good price!…. should have gone all in…. missed the jump…. now I don’t know whether the stock will go up or down….. should i sell now?…. will it go up? …… let’s just leave it alone…..
- At some point, the stock rises to a “moderate-high” level. Now you think – the stock is going up…. lots of people are buying…. alot of purchases were at the ask price… is some big guy accumulating?…. should hold on… gonna make a lot of money… ok i’ll leave the position alone… man this is exciting!….
- Perhaps now the stock proceeded to rise for 2-4 weeks already. You start to get tempted…. the market keeps going up… the economy is doing great…. companies keep beating earnings… you become greedy… you have been holding out for so long and the market has kept going up… you don’t want to ‘lose out’… you want a piece of the gains… so you buy a large position.
- The market then starts to drop again.
- Go back to point 1.
So what is the end result?
- When the stock drops, you end up not doing anything. When it reverses quickly after a sharp drop, you end up not buying much, if at all. In the end you are just hoping to break even while you get fully caught in the drop and end up not capitalising on the drop. Worse still, you end up panicking at the bottom and sell out.
- When times is good and the stock price is high, you end up not doing anything too. In the end, all the “unrealised profits” get wiped out in the next drop. Worse still, you end up buying a large position at the top.
- Meaning that in the end, you get flung around by the market.
- And in-between, you get egg-ed on to buy at the top (wow its been going up and up! i should buy everything that i can now!), and not buying enough at the bottom (damn it keeps going down and down, better not buy so much… wait and see).
- You need intelligent rules on when to buy and sell.
- To answer, is this a good price to buy now?, you need to have calculated the intrinsic value of the company. To have the confidence to enter with a large position, you need to have confidence that the price is a really good price, and that confidence comes if you had calculated the intrinsic value of the company. Still, don’t be too eager to “show hand”, space out the buying – making less is better than running out of ammo when the most incredible deal comes along.
- To answer, should i sell now?, you need to have calculated the intrinsic value of the company, else you will not know how far up can the price go, or whether there is not much more upside left.
- Nowadays, with high-frequency trading, “trends” can be created easily with little volume – you cannot just look at price patterns alone. Its too difficult to discern market flows and “trends” using technical analysis now.