Thursday, 7 August 2008

Bargain Conundrum - another cognitive error

A stock has done tremendously well for a period of time. Investors tend to extrapolate linearly, assuming that a company which has done well in the last few years is expected to continue to do so.

Then came the correction. For many buyers, it was an opportunity to get in.

Here lies the bargain conundrum - another cognitive error that consistently lead us to make irrational decisions. The belief is that the price uptrend would resume. That this correction could be a reversal may not feature in the thinking or radar of most.

One risk in the investment world that is often overlooked is behavioural risk. Recognising such flaws which the field of behavioural finance has uncovered is the first step towards being more rational in one's investing.

Also read:
Evaluating Changing Fundamentals (Part 3 of 5)
· Don't automatically buy because a stock falls in price; re-evaluate as if new.
Ask ourselves:
Is the correction a true bargain?
Maybe the price uptrend would resume?
Or, maybe not, this being a reversal of the uptrend?
Obviously, having an idea of where the "fair value" of the stock is, helps.

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