BE THE NEIGHBOUR!!! (Mr. Market and How To Handle Price Drops)
Every self respecting value investor should be familiar with the Mr. Market principle invented by Benjamin Graham. It's a fictional character who is synonym for the manic behaviour we find on the stock markets. One day he is extremely positive about the future and is willing to pay a lot of money for a share in a company, while the next day he might be pessimistic and wants to sell his share for a bargain price. This characteristic is contagious, but it is way more profitable if you can use these extremes to your advantage: buy when Mr. Market is pessimistic and sell when he is optimistic!
2 TYPES OF PRICE DROPS
If you look at the markets that way, you can to devide stock price drops in 2 categories: 1. price drops caused by manic, irrational behaviour and 2. price drops caused by fundamental changes of the company. It is important to be able to make these distinctions, because the first one can offer you a great buying moment, while the second type of pricedrop can change a business in a bad way.
SELLING STOCKS WHEN PRICES DROP
DO NOT DO THIS!!! Unless a type 2 price drop has occurred and the company's value has dropped significantly. This is why you should only buy good, stong and healthy company's at good prices. If you did that and a price drop occurs without some fundamental reasons, you should keep the stocks untill the price recovers and starts moving towards it's fair value.
I never quite understoot why people sell as soon as a price drops. Look at Apple (AAPL), which dropped 40% from it's high: bad stock price development: YES. Bad company: NO. The price drop of Apple is irrational and exaggerated, and this presents a good buying opportunity.
SIMILIARITIES BETWEEN A HOUSE AND A STOCK
Let's say you just bought a house. After a lot of searching and researching you've finally found your dream house in which you intend to live for a long time. It's a solid house which is still in a good state. It has proven itself in the past by surviving many tropical storms. The current owners have always taken good care of the house and did everything they could to keep the house in tip-top shape. So, fundamentally this house looks great.
Now the only thing left is: which price am I willing to pay for this great house? After some more research and comparison you agree to buy the house for $400.000.-. You always want to be up to date with the latest news so you read the newspaper everyday before you go to work. Everyday when you arrive at your mailbox, your neighbour will be there too and everyday he tells you he wants to buy your house...peculiar little fellow.
The first day he is willing to pay you $350.000,-. You tell him:"no, thanks", get your newspaper and get on with your day. The next day the same thing happens, but now he is only willing to pay you $300.000,-. You frown once, wish him a good day and start eating your breakfast.
This keeps on going untill after 2 weeks he is only offering you a mere $100.000,-...AND YOU ACCEPT THE OFFER BECAUSE YOU ARE AFRAID THAT TOMORROW HE WILL OFFER YOU EVEN LESS!!!
Now doesn't that sounds crazy to you that you sell your $400.00,- house, in which you intended to live for a few years, after only 2 weeks for only a fraction of the price you bought it for?! Well this is exactly what happens on the stock markets!
IMPORTANCE OF A SOLID PORTFOLIO
If you've got a solid portfolio full of strong company's bought at good prices and an investment horizon of a few years, short-term market drops aren't a good time to sell your entire portfolio.
Those familiar with our "businesspartner" Mr. Market, know that stock prices tend to exaggerate in both directions. Using those exaggerations to your advantage can make you some serious return on your investment- although the absolute tops and bottoms can't be predicted.
After a huge market drop like we have seen in the past weeks/months, after the last houseowners have sold their house to their neighbours, there will be an opposite movement of prices; up, that is. One tip: BE THE NEIGHBOUR!!!
And they both walked back inside satisfied, after emptying their mailboxes, and started eating their breakfasts...
Disclaimer: I am not responsible for any losses of money or the like because of the usage of the above mentioned methods and tips. You hold full responsibility over your own actions. And I do not own stocks in the AAPL.