Your stock has crashed. Should you blindly buy more? - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  
  • Home
  • Outlook Arena
  • May 7, 2012 - Your stock has crashed. Should you blindly buy more?

Your stock has crashed. Should you blindly buy more?

May 7, 2012

Opportunity cost is defined as the cost of an alternative that must be forgone in order to pursue a certain action. It's the benefits one could have received by taking the next best alternative action.

The concept of opportunity cost is something that we come across in our daily lives. We use the same when making various decisions. For example, what are the different activities one could do on a Saturday evening? Spend time at home with family, meet friends, watch a movie or grab a meal at a restaurant - are just some of the choices.

Now, let's discuss a more relevant example.

Suppose an investor has the option of investing in a risk-free instrument such as a fixed deposit and a relatively higher risk stock A. Based on assumptions, he expects stock A to generate a 15% return over one year, while the fixed deposit will guarantee a return of 8%. In this example, if the investor chooses stock A over the fixed deposit, the guaranteed 8% return is his opportunity cost.

Charlie Munger has explained this concept aptly - "Everything is a function of opportunity cost. The concept of a hurdle rate makes nothing but sense, but a lot of people using this make terrible errors. I don't think there's any substitute for thinking about a whole lot of investment options and thinking about the returns from each."

What Mr. Munger explains here very well is that every time an investor decides to invest in a stock, he should always consider other opportunities available to him. Comparing investing in a stock with its peers is essential.

Similarly, when one already holds a stock that has fallen substantially from the purchase price, one should refrain from blindly purchasing more units of the stock. 'Averaging', as the practice is commonly known, is not rational by itself. Gauging and evaluating other opportunities presented at the same time is of utmost importance. This is precisely where the function of opportunity cost steps in.

A good practice would be for investors to judge the reason for the stock's downfall. He should also re-evaluate how the stock (and its valuations) compares with other alternatives after the decline.

The concept of opportunity cost is of utmost importance as it helps in avoiding the mistake of blindly averaging one's previous purchases, a practice that is followed by many investors.

Equitymaster requests your view! Post a comment on "Your stock has crashed. Should you blindly buy more?". Click here!

  

More Views on News

It's Time to Book Profits (Fast Profits Daily)

Nov 27, 2020

In my first video on Equitymaster, I want to introduce you my proprietary greed and fear index. It's telling us to book some profits in the market.

Mirae Asset Large Cap Fund: Participating in High Quality Businesses (Outside View)

Nov 27, 2020

PersonalFN's analysis on the features and performance of Mirae Asset Large Cap Fund.

Create Wealth for Yourself in India's Drone Revolution (Profit Hunter)

Nov 27, 2020

The Chinese drone market is 14 times that of India's. Billions may flow into Indian drone companies too. Don't miss out on this wealth creating opportunity.

Two Very Important Updates For You (Fast Profits Daily)

Nov 26, 2020

In this video, I'll have an update for you on gold and the new member of my team.

Adani Green: A Future Multibagger or a Big, Speculative Bubble podcast (Views On News)

Nov 26, 2020

Rahul Shah discusses the hype around Adani Green Energy and analyses whether it is justified.

More Views on News

Most Popular

Top Investing Gurus of India

Investing gurus are the champions of value investing. These are the people who've mastered the art of compounding wealth from...

Not Infosys or Wipro. India's Next Wealth Creators Could Be Drone Stocks (Profit Hunter)

Nov 25, 2020

India's drones directorate signals the next big defence tech multibaggers.

Stocks that Could Shine More than Gold After Diwali (Profit Hunter)

Nov 17, 2020

If the markets become volatile over the next few months, do this.

How the New Margins Will Impact You (Fast Profits Daily)

Nov 25, 2020

The new rules on margins will come into effect from 1st December. Are you ready?

How to Build the Best Trading System (Fast Profits Daily)

Nov 20, 2020

In this video, I'll show you how to make the best trading system.

More

Covid-19 Proof
Multibagger Stocks

Covid19 Proof Multibaggers
Get this special report, authored by Equitymaster's top analysts now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Nov 27, 2020 (Close)

MARKET STATS