When investors find out that a particular stock in their portfolio has experienced a marked decline, panic starts to set in. “What do I do now?!” becomes the question of the day. The more fundamental question should be “Why did I buy this stock in the first place?” The “what to do” question is answered differently, depending on whether you purchased the stock as an investment or a trade. If the stock has great fundamentals and you intend for it to be an investment, then the most logical answer is to buy more (it is on sale!).
If the intent was to buy it as a trade and capture some quick returns, then the most logical answer is to cut your losses and sell. Always keep Jim Cramer’s rule about this in mind: “Never turn a trade into an investment.” It is psychologically pretty easy to ignore the rule because we don’t want to take the loss. We fabricate a good story as to why the stock is a good investment and how it will go up in the future and the loss will turn profitable. This will usually lead to even bigger losses.
This practical lesson has a deeper lesson in it: How you believe investing should work has a huge impact on the decisions you make and how you execute trades. Much of the discussions below are oversimplified, and will not do the perspectives being considered justice. I encourage you to delve deeper into them. Most of them are voodoo to my way of thinking and have no place in a serious investor’s toolbox. I freely admit that I am biased in this regard, and I will make my biases clear in later chapters. For now, examine each of the theories and strategies below and try to rip them to shreds in your own mind. Perhaps the ultimate goal of financial education is to eliminate all of the nonsense and get down to a few key principles that really work.