You need to approach investing decisions with certain mental models. We all have different mental models, and I’ve written about the punch card and circle of competence. In this post, another one is discussed: How would you act if the price drops?
Price Drops Will Happen. How Certain Are You?
Intelligent investors need to ask themselves when they’re buying: What’s the value of the business? How certain am I in my conviction? The punch card is an excellent filter to eliminate uncertainty, but here’s another question to ask: If the price drops (after buying), would I be willing to buy more stock?
Granted, you should not buy more stock if the fundamentals change, or if the price drops due to serious bad news. However, if the price drops and you can’t find any rational reason for it, there may be an opportunity to widen you margin of safety. By widening the margin of safety in a price drop, you increase your potential for return on investment (and return of investment). I’m not going to lie; Acting on a price drop is the ultimate test of your conviction. When this happens, your psychology kicks in and you start to doubt your initial decision; What if I made a mistake?
Once Again, Refer To The Facts
In order to fight your emotional brain, refer back to the facts. Look at the reasons you bought the stock in the first place. It probably passed your filters. You still understand it, has the same management and competitive positioning. Only now, you can get it for an even better price. If you’ve done good valuation, compound interest can now make a significant difference. In the long-run, the market is always a weighing machine. The facts will be exposed, things are not as bleak as they seem after all. Mr. Market will correct his mistake, and appraise the stock price according to value. Corrections are inevitable; either down from ridiculous highs, or from dismissed back to rational.
Takeaways
- Use the mental model in your investment decisions: Am I willing to buy more if the price drops? As long as the fundamentals have not changed?
- When price drops happen, calm your monkey brain by referring to the facts.
- The future is by definition unpredictable. There are only well-informed guesses. Mr. Market will always correct miscalculations in the long-run.
Almost always when I buy into a position, it’s on its way further down. It’s as if the stock knows: “Alright, IGTSKasimir took a position, time to give ourselves a real beating”. You need to get comfortable with being uncomfortable.
Do you buy with the intent on buying more during price drops? Please give your thoughts below!
-IGTSKasimir
Further Reading
Warren Buffett – The Partnership Days (1956 – 1969)
Philip A. Fisher – Lessons From The 15% Man
The Best of Ben Graham – Security Analysis
Phil Town – The Compounding River Guide
Margin of Safety – The Most Important Thing
Intelligent Investing = Thinking In Probabilities
The Emotional Stages of a Value Investor
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