Editor’s note: This article contains information only. It is not intended as personal or general advice. Your Money recommends seeking professional advice specific to your personal circumstances.
Buy low and sell high: the simple equation for success in share trading.
With a bit of luck or a sound strategy, your cheaply-bought shares might continue on a steady uphill trajectory.
But in reality, your equity holdings could very well drop dramatically, leaving you scratching your head.
Howard Coleman, trader and co-founder of Teaminvest, shared his tips for responding to your plunging shares with Trading Day.
The question you need to ask
Coleman says before you make a move, you have to ask the right questions and get to the bottom of the drop.
“The first question you want to ask yourself is: Has it dropped dramatically because the business has done badly, or [is it] simply that the market is currently prepared to pay less for it?”
Knowing the difference will help determine whether you should hold tight, sell out, or maybe even buy more.
When to get out fast
There are times when business disasters are a signal to sell.
If the business has performed poorly because of management errors such as a failed acquisition, they’ve copped a big write off, or the profits have dropped dramatically, then you don’t want to think twice about getting out.
In these situations, Coleman says: “the faster you get out, the better.””
When to keep calm and carry on
However, if the company is continuing to do well and the earnings per share continue to rise despite your shares dropping, you’re in safer waters.
If the price-to-earnings (P/E) ratio of the company is dropping at the same time, you might find yourself instinctively reaching for a life jacket. perhaps unnecessarily.
“That is an opportunity to hang on to it because it is a great bargain. If it looks really good, consider buying more of it.”
Coleman says that even though a declining P/E ratio can be concerning, perspective is everything.
The P/E ratio reflects the earnings potential of a company in the eyes of investors. A decreasing ratio might sound like trouble, depending on whose shoes you’re standing in when you look at it.
“‘Fund managers are trying to talk up the market, whereas private investors are waiting for the market to go down so they can purchase at the lowest price,” Coleman told Trading Day.
“If I want to go down to the shops and buy some things, I’d prefer to get them on a discount. But for the salesman selling it, he would prefer the price to be as high as possible.”
Context is everything
Coleman also explained that your personal perception of an influencing event is important, using Brexit as an example.
If the business is reliant on the UK market and could be influenced by Brexit, then your own perception of can guide your decision.
“A lot depends on your view of Brexit…If you’re prepared to hang on a few years, you’ll more than make up most of what you’ve lost.”
Brexit is causing a lot of people to want to avoid UK-domiciled companies because of the market uncertainty, but it won’t last forever.
It comes back to asking the right questions about your shares’ drop.
The market being prepared to pay less for your shares isn’t as damaging in the long-term as business disasters like failed acquisitions.
Listen to Howard’s full commentary in the video above.