You can do everything right in the investment world and still get burned...
You analyzed all the competitors in the industry, you crunched the company's numbers, and you felt you were paying a fair price for the stock... The only problem was your timing.
You chose a too-tight stop loss during a market correction. As a result, you were knocked out of your position before your investment thesis could really take off.
You have stop losses in place for a reason. They protect you when you get it wrong. Legendary hedge-fund trader Paul Tudor Jones is known for having a handwritten note above his desk warning that "losers average losers."
But we've all had that one stock we've been stopped out of that we knew we were right about...
The key mistake to avoid is trying to "catch a falling knife." As a stock falls, it does get cheaper, but timing bottoms in asset prices is the hardest way to invest. You'll do better by waiting for an upward trend to form and riding that momentum.
Today we're going to talk about when you should "rebuy" a stock you got stopped out of. My team and I have developed some guidelines about reentering a stock...
Wait Six Months
The worst outcome in reentering a stock is to stop out for a loss... buy it right back... and stop out for another loss.
Giving yourself time to reconsider can avoid this. You may miss a buying opportunity... But on balance, this simple rule will serve you well.
Wait for Positive Momentum
It's a statistical fact in markets that stocks with prices that are already rising do better than others. Use momentum to your advantage. There are a few simple, tried-and-true ways to measure positive momentum:
- A positive 12-month price change
- The stock is above its 200-day moving average ("DMA")
- The stock's 50-DMA is above its 200-DMA
This may sound complex. And we can spend another essay diving into each of these...
The easiest thing to do would be to wait for a new high.
This may seem counterintuitive. Aren't you supposed to buy stocks when they're on sale? But a new high indicates that whatever concerns led to the stock's decline have been alleviated.
And, statistically, the most likely thing for a stock to do after it sets a new high is to set another high. Several academic papers have looked at decades of data to support this theory... One research paper by Thomas J. George and Chuan-Yang Hwang, "The 52-Week High and Momentum Investing," showed that the closer a stock's current price is to its 52-week high, the stronger it performs in the future.
Reexamine the Fundamentals
The last thing you want to do is reexamine the fundamentals. The best time to reenter a stock is when it has proven it can sustain the growth you have come to expect. And of course, you want to make sure the stock still trades for a fair valuation. You can use a simple price-to-earnings or price-to-sales ratio to determine this.
In an ideal world, we'd end up getting a business with better growth and better prospects for the same valuation we previously paid.
We don't recommend you try and reenter every stock you got wrong. You should only consider this for your highest-conviction ideas.
At the very least, wait six months, wait for positive momentum, and make sure the fundamentals are still strong.
What We're Reading...
- Something different: Apple, Google, Nvidia, and other tech giants are considering buying Arm shares.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig and the Health & Wealth Bulletin Research Team
September 6, 2023