I had a question today that deserves a good answer. I wrote it as a reply but I decided to post it here so you don't miss it. The question was: What are you doing right now with BP as it is crashing with the market?
I don't want to say publicly what I'm doing with BP specifically because I reserve that information for my students. However, if I tell you a few things you can probably figure out what I'm up without much trouble.
Consider that after I buy a business, I don't really care what the market price is for the business unless I'm selling or buying. When I buy, I buy with the idea that I'm in it forever. The only caveats to holding forever are these two: 1) the business becomes un-wonderful and/or 2) the price gets so high (into the red zone) that its not sustainable.
If I've done my homework well and assuming Mr. Market doesn't get manic, the only reason I care about price after I buy is that I want to buy more.
Actually that's not entirely true. I do care if the thing is dropping like a brick all by itself. I might have missed some rather important piece of information about my business that completely changes the value so if that happens I stop being lazy immediately, catch up on the news I should have been watching and start digging in deep on the business to reassure myself. That sort of thing shouldn't happen at all if you're paying attention but we're human and screw off a lot so it can.
Other than that, a drop like BP is sustaining is being sustained because of both industry and market-wide issues - things that should pass without changing the long term value of the business. Therefore, if the price is falling, I don't care unless I want to buy more.
The obvious question, especially if you've read my book, Rule #1, is 'why not trade it as it drops?' The answer is that you can trade it but you have to be on top of it day by day, follow the rules and be disciplined. Forget the idea that you're going to trade it on its way down and hold it on its way up. You're not going to be that good of a guesser. If you trade it, you will almost certainly trade it both directions simply because up can always turn to down and down can always turn to up so it always is the case that the stock can turn and run the other way. If you shift to trading mode and think you're going to guess that its at the bottom and starting back up you could be surprised on the next downturn and find yourself holding as it drops. Or even worse, being out when it runs up.
Its easier by far to just stockpile the thing as it drops than to trade in and out but trading in and out works. You have to factor in the 'friction' of trading - taxes and missing the occasional gap up or down. (Commissions are so low online that they only matter if you are trading a stock with less than $10,000. If you are a beginning small investor, commission costs still matter). These frictions will reduce your overall rate of return. In fact, its possible you could be trading BP, it goes up 40% and you missed the big jumps, got in late, and ended up with a 5% return. What trading does that is awesome is protect your downside. Your downside as a beginning investor is that you don't do your homework as well as you should and your 'wonderful' company turns out to be a disaster. If you stockpiled the disaster you get crushed, but if you traded in and out, you probably didn't lose much. That's why I wrote Rule #1 first - to help people get started investing who probably weren't going to spend their time doing good research. I wrote Payback Time second to help people who wanted to be long term investors, Warren Buffett style.
I do both.
I also do derivatives to reduce my basis over time. That's a whole 'nother level of skill that I suggest you learn some day. Its well worth the effort to learn how to use options to reduce your overall cost in the stock over time and to do it with virtually no risk. That's why options were invented - to take the price risk of the farmer's wheat crop to zero while taking the price risk of the baker's flour costs to zero. Pretty slick and farmers and bakers have been using derivatives ever since. I just do the same thing with stocks.
Now go play.
