Friday, 26 July 2013

Market Fluctuations and Your Emotions

The stock market can fluctuate widely.  Prices of stocks are determined by various factors.  It is better for you to focus on the fundamentals of the stocks.  However, the prices of stocks can be driven very high and pushed very low by sentiments of the players which may not have anything to do with the underlying fundamentals.

As a rational investor, what should you do in such situations?  Let's assume you own good quality companies with durable competitive advantage which you plan to hold for the long term.  You rightly have chosen these companies to be in your portfolio due to their earnings power, mainly gauged from their historical performances. 

Firstly, you should be able to compute the intrinsic values for the companies, using conservative estimates in your valuation.  This ability is important as it is the strength you will have over the other players.  It is not uncommon for your stock prices to fluctuate 50% above or the equivalent 1/3rd below its average market price over a 52 weeks period.  Check these out to confirm this statement in your local press of the listings of the various companies' stock prices.

If you hope to buy and sell to profit from these market fluctuations in the prices of your stocks, believe me that to make money consistently and to grow your portfolio value at a meaningful rate, though possible for a few, is not easy.  Frequent trading incurs costs and expenses, and also your time, which can be better employed to pursue some better, more productive and healthier activities.  Rather than hoping to profit from trading these prices, focus on profiting from the long term returns you can expect with a high degree of probability from holding these stocks with great earning power. 

How then should you approach these market fluctuations of the prices of your stock?

When the price of the stock is higher than your calculated intrinsic value, don't buy to add to your portfolio.  Do you sell based on valuation?  Often, you need not have to.  There are times when you may consider selling some (perhaps 20%), but not all, should the stock be too overpriced  Selling your winners to lock in a gain, may not mean that you will be able to buy the same back at lower prices in the future.  Moreover, the gain that you locked in at the time of selling, you may realise that you have missed out on the even bigger gains that these stocks deliver over the long term.   (Just to emphasize, this is different from stocks which fundamentals have deteriorated permanently.  These should be sold urgently to prevent harm to your portfolio.) 

Great companies can often be bought at fair prices and still be very profitable over the long term in your portfolio.  You should be greedy when such companies are available to you at low prices, especially during a general market correction or a bear market, when even these good stocks are sold down by the less savvy investors, due to fear, during such periods.

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