Imagine if you are long a stock. Great company, good valuation/growth/multiple. You have a 3:1 risk reward. Up 30 down 10. You buy stock and it goes down 5 immediately and bleeds 10 from there, with no changes to data/earnings. How do you think about cutting losses here since you haven’t been proven “wrong” yet but clearly price action is telling you otherwise. Does that change if you know the bear case vs if it’s going down for a hard to explain reason?
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Based on the most helpful WSO content, deciding when to give up on a stock, even when the fundamentals haven't changed, is a nuanced decision that involves both quantitative and qualitative analysis. Here's a breakdown of how to approach this situation:
Risk Management Strategy: Before entering any trade, you should have a clear risk management strategy in place. This includes setting stop-loss levels, which are predetermined prices at which you'll sell a stock to prevent further losses. If the stock has hit your stop-loss level, it might be time to exit the position, even if the fundamentals are still intact.
Market Conditions: Sometimes, a stock's price can be affected by broader market conditions rather than company-specific news. It's important to assess whether the decline is part of a larger trend or sector rotation that could continue to drag down the stock's price.
Volume and Price Action: Analyze the trading volume accompanying the price decline. A high volume sell-off might indicate stronger conviction among sellers, while low volume might suggest a lack of interest rather than active selling.
Time Horizon: If your investment thesis is based on long-term growth prospects, short-term price fluctuations might be less relevant. However, if the stock continues to bleed down without recovery signs, it's crucial to reassess the validity of your thesis.
Bear Case Awareness: Understanding the bear case is crucial. If the stock is going down for reasons that are hard to explain, it's important to dig deeper and understand if there's something the market is seeing that you might have missed. If you're aware of the bear case and the price action starts to confirm it, that might be a signal to reconsider your position.
Emotional Discipline: It's essential to avoid emotional attachment to a stock. Always be willing to cut losses if the initial investment rationale no longer holds, regardless of how good the company might seem on paper.
Reevaluation: Regularly reevaluate the stock against your investment criteria. If the fundamentals remain strong and your investment horizon is long enough to weather the volatility, you might decide to hold. However, if the price action is at odds with your analysis and you can't find a solid reason for the decline, it might be prudent to exit the position and preserve capital for better opportunities.
Remember, the key is to have a disciplined approach and not to let emotions drive your investment decisions. If the stock has gone down by 10 with no change in the company's fundamentals or earnings, it's important to revisit your analysis, check for any external factors you might have missed, and then decide whether to stick to your original plan or adapt to the new market information.
Sources: Is value investing dead?, Trading Ideas: Matter of Edge, First Steps into Trading, https://www.wallstreetoasis.com/forum/asset-management/sales-trading-interview-guide-gekkos-guidance-part-2?customgpt=1, What is the Shorting "Research" Process
If it’s bleeding heavy from what you projected then you should probably re evaluate the way you valued the company , what were the drivers of the stock? What are the macro conditions they effect the price ? If everything you thought was/ is gonna happen priced in? What was margin of safety ? Just probably a simple thing you skipped over that could’ve skewed the whole thesis
But there’s no clear answer to sell or hold just depends on your time horizon , I’m more of a value guy so I’d probably hold until the thesis plays out and the security gets to a good price or overvalued
It means your up/down was hot garbage
Is the stock lagging vs the market? Versus its close peers?
Is your stock "crowded"?
A quick check on all these will help tell whether it's just a market/sector move or whether something more specific to your company.
Also helps asking around sell-side for thoughts.
I usually flip a coin
Flip Harvey Dent's coin
Ask yourself: "if I wasn't *already* holding the stock, would I buy it now?" Remove the sunk cost from your mind and the answer will usually be pretty clear.
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