Updated: Feb 14, 2019
Stocks go up and stocks go down. Fortunately they go up more often than they go down but when they do go down it hurts. It hurts because we see red and we can calculate how much money we have lost from the last peak.
Many thoughts run through our heads, “should I sell and cut my losses” or “how much longer can this continue?”
In the last week, with the worries about international trade and Trump’s travel ban and all sorts of stuff, technology stocks, at least the ones I’m invested in, are down big. Granted, they were up pretty big for the first two weeks of June, but now they are back where they started. In these moments it is crucial that we have a healthy mindset if we want to be great investors.
After all, if you’re the greatest financial analyst and you know absolutely everything, without the correct behavior and emotional stability, it will be useless. How we handle our emotions is the most important part of investing because it is the root of decision making. We can know everything about a company but if we get scared and sell, then all that knowledge doesn’t matter.
However, the more we know about a company the better the odds are that we will make the best decisions possible. If you have done your homework on a particular company and you know the value of it, you will likely make good decisions. This is precisely why doing the hard work of research is so important: because it guides your decision making. If you know exactly why you’re invested in a company, if the information changes, then you can change your mind. If you have no idea why you’re doing what you’re doing, you won’t know when to change your mind.
With that said, this brings us to the most important question. To lay some more foundation, as investors, we invest in businesses, not stocks. Stocks are simply the vehicle by which we invest in businesses. And to pick which businesses we want to invest in, we pick the best ones because we want to be on the winning team. In order to pick the best ones, we look at the business results and all sorts of information to discern which ones are best. If we know that stock prices generally follow the business results, we should only focus on these results.
Sometimes, often actually, stock prices get out-of-whack with the business results and in those cases we should buy when we think the price is too low and maybe even sell if it is extraordinarily high.
In the long term, stock prices generally follow the business results though. So the number one most important question to ask yourself when the market is tanking is:
have the business results changed?
If they haven’t, carry on. If they have, maybe you need to change your mind.
If you are focusing obsessively on the stock price, it can be difficult to discern whether you should hold your stocks. Because your brain will tell you to cut your losses to stop the pain. And if you don’t know why you are holding a stock, then that fear will win. If you know the business results and the value of your stocks, then you can have emotional stability. So knowledge begets emotional stability. Like I said, it is possible for you to be very fickle and still act irrationally, but usually this helps.
So next time the market is tanking, and it will tank, ask yourself: have the business results of my stocks changed? Spend infinitely more time analyzing the business and looking at the numbers than the stock price. If you do just this one thing, you are well on your way to becoming a fantastic investor. It’s more stimulating to look at the stock prices and see all the money you’re making (or losing, but hopefully not) rather than looking through financial statements. But the latter is so much more useful as an investor. Watching stock prices is mostly counterproductive to great results as an investor. In summary, watch business results, not stock prices and you will most likely do very well.