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

Your Queries on the 8-Year Cycle Answered (Fast Profits Daily)

Sep 25, 2020

You've sent in your queries on my videos on the 8-year greed and fear cycle in the market. I'll answer them in this video.

It's When You Sell that Counts (Profit Hunter)

Sep 25, 2020

How I alerted readers to the impending crash last week.

Can the Nifty Fall to 10,200? (Fast Profits Daily)

Sep 24, 2020

The Nifty has reached an important support level today. If it breaks then we could see further downside.

How to Save Money by Exiting Stocks Before They Fall podcast (Views On News)

Sep 24, 2020

A penny saved is a penny earned. It doesn't matter where you enter. All that matter is where you exit. Watch this video to identify an opportune time to exit your investments and book profits.

ICICI Prudential ESG Fund: Aims for Sustainability (Outside View)

Sep 24, 2020

PersonalFN briefly explains the newly launched fund : ICICI Prudential ESG Fund.

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...

Why We Picked This Small-cap Stock for Our Hidden Treasure Subscribers (Profit Hunter)

Sep 17, 2020

This leading household brand will profit big time in a post covid world.

My Top Stock to Buy in this Market Selloff (Profit Hunter)

Sep 22, 2020

The recent correction offers a great opportunity to buy this high conviction smallcap stock.

Can the Nifty Fall to 10,200? (Fast Profits Daily)

Sep 24, 2020

The Nifty has reached an important support level today. If it breaks then we could see further downside.

What Do the Charts Say About Buying Smallcaps Now? (Fast Profits Daily)

Sep 18, 2020

Everyone seems to be excited about buying smallcaps now...but is it the right thing to do? What do the charts tell us? Find out in this video...

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


Sep 25, 2020 (Close)

MARKET STATS