Please ensure Javascript is enabled for purposes of website accessibility

Don't Follow the Market Over a Cliff

By John Rosevear – Updated Mar 7, 2017 at 1:46PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The herd will stampede your portfolio ... if you let it.

Suppose you decide to treat yourself to a sporty new car. After some research, you settle on a Mustang -- a bright red GT model, with a V8 and racing stripes. Six months later, the car has proven to be reliable and fun to drive, but something weird keeps happening: Strangers keep offering to buy it.

Even weirder, they aren't offering you much money for it, and the offers are getting lower and lower over time. After six months of ownership, they're down to barely half of what you paid for the car in the first place, way beyond any reasonable rate of depreciation. The car still smells new inside, it's needed nothing more than an oil change, the paint gleams, and gas prices haven't soared in the interim -- but you keep getting these lowball offers from strangers.

Would you sell your nice almost-new car for half of what you'd paid and cut your losses? You'd probably call me crazy for suggesting it. But what if I wasn't talking about a Mustang, but rather shares of its maker, Ford (NYSE:F)?

Well, now, that's different
It's one thing to resist lowball offers for a car -- its value is easy to see and understand. Unless you're actively looking to sell, you don't follow the ups and downs of the used-car market. But with a stock, today's price is the most easily accessible indicator of value. Even if your analysis of a company's prospects suggests to you that it's undervalued, it's hard for many of us to keep believing in our analysis, and to hold when the herd is going in the other direction -- making those lowball offers for your stock.

And the worst part is, those lowball offers make many people more likely to sell. As I mentioned recently, most people hate losses more than they like gains -- about twice as much, according to research. Combine that with the speed at which market drops tend to take place, and you see lots of panic selling -- people cashing out to avoid the pain of further losses.

Selling because everyone's selling
Want an example? Take Ford again. Its price is down 15% since the beginning of July, despite reporting a surprise profit -- its first in two years. If anything, Ford's fundamental picture is better than it was a month ago, but the price has been clobbered, along with the share prices of hundreds of other companies.

Why? Well, we could argue that it's all about the subprime crisis. The well-publicized failure rates among subprime mortgages have hurt everyone from mortgage-trading hedge funds at Bear Stearns (NYSE:BSC) to homebuilders like Beazer Homes (NYSE:BZH). Many fear that those problems will also lead to tightening credit that could hurt car sales. Surely that's motivated some selling. But it's also true that lots of people sold Ford stock (and hundreds of other stocks) because lots of other people were selling Ford stock, and stocks in general -- because prices were falling, in other words.

Ignoring the herd
If you find yourself tempted to sell during a market swoon, stop and ask yourself a few questions: Has the story behind this stock changed? Are the company's long-term prospects now in doubt? Remind yourself why you bought the stock in the first place, and ask yourself whether that reasoning is still valid -- regardless of what the CNBC talking heads are saying. If it is, don't sell.

And never forget that market swoons happen from time to time. As Benjamin Graham famously said, Mr. Market is a manic-depressive fellow. When he's happy, prices go up. When he's depressed, they go down. These swings don't have anything to do with fundamentals, but too many people still buy when prices are up and sell when they're down. If you want to make the big bucks, don't follow the herd.

Want help finding good stocks left behind by Mr. Market? The Fool's Inside Value newsletter picks two new ones every month. See this month's recommendations -- and all past picks -- right now with a free 30-day trial.

Fool contributor John Rosevear invites you to send him your comments, questions, and ideas. He does not own any of the stocks mentioned. The Motley Fool has a disclosure policy.

None

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Ford Motor Company Stock Quote
Ford Motor Company
F
$12.31 (-3.60%) $0.46
Beazer Homes USA, Inc. Stock Quote
Beazer Homes USA, Inc.
BZH
$10.97 (-1.26%) $0.14

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
329%
 
S&P 500 Returns
106%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/24/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.