One of the most common arguments in favor of holding on to a losing investment is an overwhelming belief in the company. Often times you will hear “this is just a short term pull back, it’s time to buy more!!!” or “The analysts forecast better than expected earnings for the next quarter… I think I’ll hang on”. Time and time again investors fall in love with a stock because of a belief in the underlying product or service. While the business model of a company and overall health of its sector definitely play a role in its perceived value, the share price is merely a function of supply and demand. Publicly traded companies generally trade many times beyond their “real value” as investors clamor to buy shares for fear of missing out. Just take a look at the Book Value of any of your holdings and you will see what I mean. The book value of a company reflects the total value of the company’s assets that shareholders would theoretically receive if a company were liquidated. Apple (NASDAQ:AAPL) is currently trading at $544.00/share however its current Book Value is $137.40.
People buy the shares because they expect that they will trend higher. Taking advantage of this kind of an uptrend is important however following the herd blindly can be devastating.
The active investor must realize that there are new and uncontrollable variables entering into the market every day. The market is a big voting machine and sentiment can change at any time leading to losses as profits are not protected and risk is not managed. And by the way, it’s not a profit until you sell. While you are still holding the shares, your profits are there for Mr. Market to take.
Let’s consider Apple once again. When the shares were trading up at $700.00, the talking heads were calling for $1000.00/share leading unwitting investors into thinking that buying shares at $700.00 was a bargain. Almost immediately, the shares plummeted over the subsequent 9 months to a low of $400.00 in April of 2013. That is a 42% drop in value. Admittedly the shares may be on the mend presently, but you would have to have an unbridled, blind love for the company to allow a 42% loss of value to take place without realizing something was wrong… however they do say that love is blind.
When a person invests with their heart they open themselves up to a stomach turning emotional roller-coaster ride. This results in a failure to make rational decisions.
Here are a couple ageless quotes:
The law of price is the law of brain. The value of the finest silk dress ever made is what fools are willing to pay for it, and that is determined by the vanity of the fool who bids highest.
17 December 1882, Grand Forks (ND) Herald, pg. 1
The price of a thing is what people are willing to pay for it, and the disposition of the public changes with the times and circumstances.
6 February 1883, Wall Street Daily News, pg. 1
Investors must recognize that price action dictates everything. They must make decisions based on rationale thought with a focus on capital preservation and risk management. There are many technical signals that can help with the decision making process and just as many ways to manage risk and protect profits
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