What should you do when your favorite stock crashes?

Accusations, clarifications and rebuttals have gone in left, right and centre. and through it, fOLO On Public Offer (FPO) of Adani Enterprises. Fully subscribed.

It would seem that the storm has passed. But even so, the shockwave this event has created will remain in the minds of retail investors for a long time.

And with the Union Budget round the corner, stock market volatility has skyrocketed. This is particularly troubling for traders, but investors will also be cautious.

In fact, even post-Budget, we can expect at least some more volatility, even if Adani Group shares fall.

This volatility will affect some stocks more than others. something is bound to happen Shares will rally due to specific announcements in the budget, And there will be some who will crash.

What if you own a stock that is going down fast? Do you sell or hold or buy more? How actively should you track it?

Well this is a situation faced by investors and traders alike whenever a high conviction stock declines.

In this editorial, we will examine various investors’ reactions to this scenario…and separate the good from the bad.

Do not do anything

This is a common approach of retail investors whenever they have a big correction in a stock.

Often there is one stock that everyone in the market is bullish about. The fundamentals of the company are strong. It is one of the fastest growing companies in India. Early investors have made a lot of money and investors who came late to the party are also making money.

Why won’t everyone buy this stock? Well, they often do. And the share price soars.

Same has happened with the Tata Elxsi. when the share price crossed No one was interested in selling 10,000.

But even when the stock started falling, many retail investors held on. The stock fell more than 40%.

This approach is tantamount to giving up. Investors throw their hands up and expect the stock to recover.

If it does, then they heave a sigh of relief. But what if it isn’t?

Well, then they would end up not only posting losses but also missing out on other opportunities in which they could have invested their meager capital. This new stock could serve to offset their losses and earn some profit on the top.

Clearly, this is a bad approach.

sell quick and forget about it

This approach works well if the company in question is monotonous.

Consider the stock of Vakrangee. It crashed in early 2018. The stock fell nearly 95%. Many investors lost their shirts.

But the investors who sold quickly regardless of profit or loss in the stock have been proved right. The stock was never recovered.

Thus, if you suspect that something is seriously wrong with a company, perhaps some fraud, it is a good idea to sell all your shares and not look back.

But what if it doesn’t happen?

Then dumping your stocks in a panic is a bad idea. When the stock inevitably bounces back, you will regret the hasty decision.

A good example is M&M’s. The stock fell more than 60% in March 2020 from the beginning of 2018. It was a brutal reform. But now look at the share price.

The polar opposite examples of Vakrangee and M&M should convince you of the need to do due diligence when it comes to company fundamentals before investing in a company’s stock.

Thus, selling quickly is not always a good approach. This is only good if the company is shady. But in that case, you should not have invested in it.

buy more

This approach is called averaging. This means that you buy more shares of stock at a price lower than your original purchase price.

For example you bought a stock 100, let’s say 100 shares, for one 10,000 invested…and the stock falls 80.

You are not worried as you have already done your research and know that the fundamentals of the company are sound.

Thus, you conclude that the decline is temporary.

Now if only buying into the stock was good 100, it’s an even better buy 80. So, in this manner, you buy 100 more shares at 80. You now hold 200 shares at an average price of 90.

A better way to average is to invest the same amount on both the occasions, ie 100 more 80. You get 100 shares from the first transaction and 125 shares (10,000/80) from the second transaction.

it also gives you the average cost of 90 but you end up with more shares than in the first example.

This is how Mutual Fund SIPs work Just replace shares with ‘units’ of Mutual Funds. When the market goes down you have more units and when the market goes up you have less units.

Picking individual stocks as a retail investor may be the best approach when faced with falling stock prices… but there’s a catch.

It takes conviction to buy more of your favorite stock. If you don’t have that then you can’t even think of buying more.

Imagine an investor in M&M’s over the past 6 years. When the stock fell in 2018, if he chose to do nothing, he must have felt relieved when the stock recovered sharply after the Covid crash.

But if he had faith in the fundamentals of the business and the efforts of the management, he could have averaged 50-60% less than his initial purchase price.

imagine buying a good stock at with a target of 100 200 and then getting the opportunity to buy it again 50.

when the stock is finally done 200, your initial investment would have doubled but your subsequent investment would have quadrupled.

This is the power of this approach. All great investors practice this in every market correction. But to do so, you need a high level of confidence in your investments.

There is another way also. Some investors try to be shrewd traders and sell their shares with the aim of buying it back at a lower price later.

If you think you can do this successfully, then by all means go ahead. But remember, this approach requires you to focus on the markets and especially the stocks. This can be the cause of a lot of stress. Keep this in mind.

in conclusion

Well, these are the various ways in which most of the retail investors try to handle falling share prices.

Sophisticated investors use other methods like hedging, shorting, covered calls etc. but these are not generally practiced by retail investors.

What do you think, dear reader? How do you handle falling share prices? Do you have any special strategy for such times?

Disclaimer: This article is for information purposes only. This is not a stock recommendation and should not be treated as such.

This article is syndicated equitymaster.com