About a month ago, I told a good friend of mine to buy shares in a small developmental biotechnology company. The company is working on a way to treat hard tumors that will be a game changer if it is successful.
Investing in companies like these is not recommended for brand-new investors. But my friend is relatively experienced.
The stock in question was purchased at $2.70 per share.
Soon after he made his purchase, the stock went down to $1.50.
Even though the price of the stock was $2.70, it was still a paper loss of 42%.
My words to him were to hold on. I am long a lot more than he was – and I wasn’t worried at all.
Fast forward to last week. This stock was now at $3.00. I asked him how he was doing.
His reply was “not good”…because he’d sold most of his position when the stock hit $2.80.
When he told me that, I already knew what had happened: that sudden 42% drop caused him to panic, and at the first chance of breaking even, he took it. Now the stock is at $3.77, and he’s kicking himself for selling.
I explained to him that the reason I am long this stock isn’t because I think it’s going to $10 – I’m long because this company could be a game changer, pushing the stock price to triple digits!
I don’t care how much research you do on a particular investment. The price of your stock will fall at some point – I guarantee it.
What do you do when this happens?
It depends on the scenario:
1. If the stock falls below your cost basis, don’t buy. For example, let’s say your plan is to invest $5000 in a stock. Once you have depleted your investment capital, i.e. invested that first $5000, do not buy anymore if the stock is lower than your average. If your average purchase price is $7.00, for instance, don’t go below $7.00.
2. If you have not exhausted your investment capital, you should continue to buy until you hit your desired investment amount. So if the stock price is falling and your plan is to invest $5000, you continue to buy until you’ve purchased $5000 worth.
3. Rules 1 and 2 should be followed – as long as nothing has fundamentally changed regarding the company. If it is learned that the company is committing financial fraud, for instance, sell your entire position and never add to it.
I’ve said this before – When we panic, we lose money 100% of the time.
When a stock you buy goes down, remember: stock prices fluctuate over time. As long as the investment thesis is intact, there is no need to worry.
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