Now, a question that people sometimes ask me with regards to selling is if they should cut loss?
Well, from a valuation perspective, if we got into a stock which we thought is worth $10 a share at, say, $8 a share, and if the price should fall to $6 a share, should we sell?
OK, let us push this a little and let us say we thought the stock is worth $10 a share but for some reason, we bought it at $12. At $6 a share, should we sell?
I think you know the answer.
Well, if we need the money urgently because there is an emergency at home, then, we don't really have a choice, do we?
This is also why we must always use money we can afford to lose for investing.
If we don't need the money, everything remaining equal, should we not be thinking of buying more if prices fall?
This is why we must always have a war chest ready!
What we have to remember is that we want to buy at a price we would not sell at and sell at a price we would not buy at. This is a general mantra we should chant to ourselves and embrace its spirit.
Although we might think that $10 for a certain stock is cheap, it does not mean that it would not become $8 or $5 or even $2.
Of course, if we are sure that our facts are correct and our reasoning is right, we should be buying more as prices fall.
Isn't it risky to buy more as prices fall? Of course, there is risk involved. Cheap could get cheaper. This is why I feel that some knowledge of technical analysis (TA) is useful.
Purists in fundamental analysis (FA) will pooh pooh at this idea, of course, but unless we have very deep pockets, I think a bit of TA is useful. Anyway, I will talk a bit more about TA later.
Now, since we are on the topic of risk, some would argue that the level of risk associated with an investment should be considered when we talk about valuations.
So, in the case of a business trust, for example, if it is perceived to be more high risk in nature, we would need a higher distribution yield before we invest in it, wouldn't we?
I blogged about how this was the case for me when I invested in Perennial China Retail Trust: here.
The same goes with bonds although in the case with bonds, the holders are more lenders than investors and I blogged about bonds before: here and here.
Now, with interest rates rising and we are seeing higher coupons from 10 year bonds, the risks associated with REITs have risen.
This is why their unit prices have fallen because Mr. Market is now demanding higher distribution yields for investing in a riskier instrument compared to 10 year government bonds. I am not saying anything new, of course.
As anyone can see, there is no one size fits all valuation technique.
So, some have thrown up their hands in despair and decided that they would only use charts to help them decide when to buy and sell. TA gives us a peek into Mr. Market's psychology.
We then buy and sell based on technical signals which tell us the sentiments in the market.
Of course, TA is about probability and never certainty.
TA is about managing probabilities!
There is no exactitude, no matter which approach we choose to use. There are only approximates.
As long as we are approximately right, we are better off than being exactly wrong. This is good enough.
This is what Warren Buffett would say. If you have yet to watch the video on why he is the world's greatest money maker, watch the video: here.
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Valuation is a subjective exercise and often, whether to BUY, HOLD or SELL, we have to rely on experience too.
If there was a magic formula that worked all the time, Warren Buffett and any investment guru for that matter would never have made bad investment decisions in their careers.
So, it is important to remember this and not become narrow minded when we think of valuations.
Related posts:
1. When to BUY, HOLD or SELL? (Part 1)
2. Recommended books for FA and TA.
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