When Your Stocks Crash, Here’re 2 Things You Shouldn’t Do

If you find that your stocks are down since 2015, don’t be surprised.

For instance, Singapore’s market barometer, the Strait Times Index  (SGX: ^STI), has fallen by 26% from its peak in 2015 (reached in April) to last Friday’s close.

Furthermore, only seven of the 30 stocks that make up the Straits Times Index had produced a positive return in 2015. The three worst stocks came from the likes of Noble Group Limited (SGX: N21)SembCorp Marine Ltd (SGX: S51), and SembCorp Industries Limited (SGX: U96).

In such a situation, your stocks may have fallen hard – or even crashed. The natural question could be what should you do? Thing is, it may be instructive to start with things you shouldn’t do. Here are two:

1. Have the idea that “I have made a mistake. I am a terrible investor”click here.

2. Have the idea that “I bought it at $5, it’s now $3 – so, I should average down”

The idea of averaging down can be attractive right now. By purchasing more shares at lower prices, you are in effect, reducing the cost basis that you paid for your original shares. In doing so, you may even feel a little better because the percentage losses versus your cost basis will come down too.

But, averaging down can turn out to be a horrible idea if the underlying business of the stock in question deteriorates further, causing the price to drop even harder.

This behavioural inclination to want to average down is rooted in a common human bias called anchoring.

The unfortunate truth is that the stock market does not care what price we had paid for our shares. Furthermore, the price we had originally paid for a share tells us little about the underlying business, moving forward. If we choose to buy more shares of a company, we may want to do so on the basis of good underlying business performances rather than a lower share price alone.

Over the long-term, it is the business performance of a company that will be the main driver behind the future performance of its stock.

The key point is this: A share price drop should not prompt us to automatically average down.

Instead, a market decline could be the best moment to use our time to read and understand the underlying business performance of the stocks we’re interested in or already own. By doing so, we may catch sight of companies that have had great business performance but poor stock market performance. In turn, it may then lead us to stocks that can outperform over the long-term.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.