Monday, April 23, 2012

What to do when your favourite stock crashes?

Investing is all about doing your homework. You read up on a company, study its fundamentals, understand its business and then buy it when valuations are right. And if you have done your homework right, you can sit back and watch the show. In the long run you are bound to make money and earn handsome returns. But what happens when this favourite stock of yours comes crashing down? Well, most investors tend to skip a heartbeat when that happens. And the big question that haunts them is what should I do now? Should I sell the stock and book losses? Or should I hold on to it like I had initially planned? 

The answers to these questions are to go back to your homework. The key is to study what went wrong. The sudden crash can be a result of either of the two things. The first is a one-off event like quarterly numbers, rupee movement, etc. These are not permanent events but the stock markets tend to react sharply to them. If the event is not permanent, then the impact on the stock should not be permanent either. Hence no cause for worry. Your long term view should remain. 

The second is a more serious problem. And that is a change in the fundamentals of the company. This could be the result of change in company policies, acquisitions or business sell offs, change in government regulations, etc. In all, events that are more permanent in nature and hence impacting the overall fundamentals of the company. If the fundamentals of the company have changed and are no longer in line with your previous estimates, then there is only one course of action that remains. And that is to get rid of the stock and book losses. 

So the bottom line still remains the same. Whether there is a crash or a boom in the stock price, always go back to the basics. If the fundamental strength of the company is intact, such crashes should be viewed as an opportunity to reduce your cost of purchase, i.e., buy more of the stock. If fundamentals are no longer the same, then it is time to get rid of your favourite stock. 


I find the above mentioned Equity Master free newsletter a great source for unbiased information about the Indian Financial markets, especially since being a doctor, I do not have a detailed financial background.

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