Did We Screw Up With Our Stock Selection?

Digging and reading thru some old stuff, I found the following set of writings. No, they are not mine they are from an investing forum based in Singapore but unfortunately that forum, wallstaits, has since closed down. (iinm the writings were from 2005)


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Investment lessons learnt this year and advice for newbies

When I just started investing late last year, this was the first investment website I stumbed upon. I was greatly influenced by its FA bent and the eloquent arguments from fellow forummers.

I have some advice for newbies from personal experiences as a newbie.

There are certain practices advocated by FA proponents that newbies need to be careful of.

The first one is with regards to averaging down. FA proponents like to say when the share price of one of your holdings goes down, you should buy more because it has become cheaper. So, when prices are depressed, you should be happier because you can buy more of the same good thing more cheaply.

You could try that if you have sufficient grounds to be so confident of your investment. But if you are just starting out as a newbie like me, please cut your losses and don't compound your mistake. You make a purchase, the share price goes down -> probably you made a mistake. Who are you, little junior, to argue against the market? If you are a newbie, assume you are an idiot waiting to pay school fees and don't average down. Cut your losses!!

Perhaps the most valuable advice that I have received from FA proponents is to know your investments very well and avoid those which you only vaguely understand. If you know your investments with the depth that Warren Buffett has with his, then you can average down with less worry.

One of my mistakes was to make investments based on superficial understanding. True, I read prospectus, annual reports and even taught myself accounting so that I could understand financial reports better. Most of my investments were made based on favourable financial ratios without a deep understanding of the business nature. I did not try out the company's goods and services. I don't know if the company's customers, employees, suppliers are satisfied with it.

My main fault as a newbie was to be over-confident. I thought after reading and learning so much, I was ready. I thought I could be as good as the masters and followed one of their strategy -- concentrate your eggs in one basket and watch that basket carefully. Once again, I reiterate that such a strategy is meant for the masters. If you are an amatuer, it is safer to assume that you are an idiot and to protect yourself from stupidity, please diversify. By putting all your eggs in one basket, you may have fatally injured yourself by catching all the falling knives with one hand.

Some FA practitioners do not have a stop-loss policy. They use a similar argument - if a good thing becomes cheaper, I should buy more instead of selling it away.

The TA approach "Cut your losses and let your profits run" is worth considering. It is a safe way to protect your capital. Sell after your losses reach 10% of the intial capital outlay no matter what. After all, he who fights and runs away may live to fight another day. In fact, by adopting such an approach, you could protect yourself against CAO, Informatics and Auston.

Unfortunately, I did not follow the advice above. I waited until fundamentals have clearly decayed before thinking of selling. In the meantime, I continued to average down as the price slided down. When the financial report was out, fundamentals did look bad but ALAS!!, it is too painful to sell now.

This is one of the problems with FA. You can only make decisions an a quarterly or half-yearly basis which by then, the price may have slid to a psychological unacceptable level to sell.

FA proponents like to say making decisions based on price movement is nonsense. Say, the management has been trying to hide important fundamental data from the financial reports for as long as they can. The silent accomplices - auditors and independent directors - who are on their payroll prefer to close one eye or both eyes as long as they have ready excuses to plead ignorance and other disclaimers when the situation implodes.

The poor FA practioner will continue to average down, thinking that he is profiting at the expense of the foolish irrational market. Meanwhile, the insiders are selling the stock down to the sucker - that foolish guy averaging down.

In such a situation, the TA practioners will be safe. Having observed that the price has been in a downtrend caused by insiders selling down, they would have already sold out before the bombshell explodes. In the cases of CAO, Informatics and Auston, the price chart has shown an obvious downtrend before the explosive truth was out.

Are there any other advice and warnings fellow forummers can share with future newbies?

PS: I do not want to get into a TA vs FA debate. If any FA proponent thinks I am wrong, please point it out objectively without making personal remarks. I am still learning and am considering using a mixture of both FA and TA at the moment.


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I agree that averaging down is a scary thing. When you buy a stock like you buy a business (which means price is only one small component of your overall analysis) and the price falls-- what I do is ask myself "if the business is failing"? A falling stock price may be a sign of danger as other savvy investors see flaws with the business model, increasing competition (usually seen as narrowing profit margins), etc. Or, sometimes it is an over-reaction to what you believe is a temporary setback, like rising commodity prices.


If, after raising your skeptical antenna, you continue to believe your business is on track to continue its long term growth and build shareholder value... than the proper (if corageous) thing to do is buy more shares at the now more attractive price. After all, it is the same business you previously liked at a higher price.

If, on the other hand, your heightened skepticism results in some important questions needing answered-- maybe about intensifying competition or rising raw material costs-- you might want to sit back and wait and study further. But, cut loss on rumors and whims isn't likely to make you wealth. Often, you will be selling into weakness with the irrational crowd without confirming any business weaknesses. A cut-loss system, or any other system that doesn't require careful analysis and thought, is not very wise and not very FA-ish.

An example... Warren Buffett accumulated shares of the Washington Post during the 1970s recession, and bought more during a newspaper union employee strike. He saw these as temporary troubles, while others were cutting losses. He is now up more than 10-fold. He bought American Express during troubled times, he bought Geico Insurance when it was in trouble too. He looked at the falling share prices in each case, and decided to buy more, because he believed the businesses were sound and their troubles temporary. He was usually right.

Most important aspect of FA... be careful you only buy good businesses at fair prices. If you get this right, you eliminate most worries about cutting losses. Step 2... remember Ben Graham's advice... "Never buy a stock simply because it has risen sharply in price or sell one because it has fallen sharply in price. The opposite advice would be wiser."



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My comments:

Excellent advice!!!

And more so I believe in that one Mr.Soros quote "I am rich because I know when I am wrong"

So when the stock you purchased, tanks after your purchase, don't just blame it on bad luck but ask oourself this simple question:  Did we screw up with our stock selection?

And if you did, averaging down means u are buying more shares in a wrong investment!

Doesn't make sense, does it? Remember CUT YOUR LOSSES!!!!

And Warren Buffett use to say "The most important thing to do when you find yourself in a hole is to stop digging!"

Doesn't it make sense?
Think about it. What does one do when one make a mistake? Don't we want to rectify it? And isn't the best way to rectify it is by stop being wrong?

Do think about it.

So the next time you see losses for a stock in your portfolio, instead of buying more, ask yourself a simple question, 'did you screw up'?

Or perhaps the stock selection might be good, but if you overpay for your investment then the chances of success in this investment would be very slim, yes?

But then... I know .... some would not agree.

They will just HOLD long la. Be patient la. The stock market bull will come and if if you hold it long enough, you can sell your mistake without a loss.

This is their version of buy and hold.

Yes that's so possible and since in a bullish market, most stocks do stand a chance of making a comeback.

But... isn't such a strategy a game of chance then?

Aren't we hoping that the bull market will be kind and help correct the stock selection mistake?

And to make it a bit more complicating.....  in a bull market .... have you consider that it's possible to have individual stock crash(es) ?

How?

I dunno ... me just mumbling ya.