I came across Ben Carlson’s latest article where he talks about the psychology of being greedy while others are fearful. In it, there is this part that seems rather interesting:
In his piece Arends showed that Russian small caps were down 78% as of the beginning of March from the all-time highs. Since then, they’ve dropped another 40%. That stings. But in the grand scheme of things that only drops the cumulative total loss to 87% in total. As the numbers approach zero (hopefully the stock market of the 8th largest economy in the world doesn’t make it that far) you need a much bigger drop to add to the total loss. So a 40% loss only added another 10% or so to the bottom line since 2007.
To go from an 80% loss to a 90% loss requires another 50% in losses.
Unfortunately, when trying to catch a falling knife, timing can be everything. Which is why it probably makes sense for most people to either stay away from these types of speculative investments or dollar cost average over time with an established time horizon measuring many, many years.
Whenever things are falling, there are always these sounds entering your head “sell now while you think things are going to get cheaper”, “don’t be a vegetable head while others are collecting cheap”
When price becomes the determinant rather than value, one of the main considerations is not to get into losses. And each of us have a different level of losses we can take.
However, sometimes, perhaps we are just bad at math, to understand we may be self-snooking ourselves:
Suppose we have 4 different investors purchasing the same stock that was originally at $1.00. The difference between them is that, each of them got invested at $1, $0.75, $0.50, $0.25.
On first examination, it is definitely better to sell first and buy back at $0.50, if you feel the stock ‘can get cheaper’ at $0.80. The problem is that at $0.80, the stock still can get cheaper.
Aggregate Pain Level
If it eventually hits $0.25 before going up, Investor A would have held on to a paper loss of 75%, but Investor B is not too shabby, losing 66.7%. Investor C who possibly think he is safest from this carnage, would have lose less, only 50%. I guess Investor D is the smartest person in the room.
If your ability to make sensible decision requires you to keep your head, and to keep your head, you can only suffer less than 40% losses, Investor A, B and C would all end up selling lower.
Incremental Pain Level
If you take a look at the first negative after 0.0%, that shows the ‘step down’ for each investor. It gets bigger and bigger from 5% to 6.7% to 10% to 20% for the SAME stock price movement.
So if the share price fall from $0.25 to $0.20, Investor A won’t feel much difference, Investor C and D would feel more.
Its not as easy as it seems and the more important thing is for the stock to turn around. If it goes back up to $1.00, then all will be happy. However if it stays at $0.10 for long time then its not fun for all.
In case you say “why got so suay, stocks would have recover somewhat”, well this example mirrors that of my Pteris. The price was at more than $1, I bought at $0.80, and now its languishing at below $0.20. I should be glad for those who bought together with me at $0.60, $0.40 thinking this is a great bargain. We are all dead together (still vested though)
- Waiting for a market correction. What is your action plan?: Stock market corrections can feel frustrating to wait for but they will come around. Focus on your plan when it does.
- Distress Stock Buying. Your favorite stock plunges. What is your plan?: Your favourite stock plunges, when do you buy? How do you know that is the right price to buy?
- Correction or not, make sure your process is sound: The market can gyrate, and that you won’t know where the market goes, but what matters is a sound plan when both up and down happens. A good simple action plan by Morgan Housel as well
- Preparing for the Recession: Stocks and Asset class setup recommended by David Rosenberg that an investor can divert into to prepare for a recession.