Originally posted at forexfactory on March 12, 2010
Don’t assume stocks have any more intrinsic value than any other financial instrument. Don’t assume stocks enjoy a certain price ‘floor’ just because there is a company trying to make a profit. Financial instruments don’t sell for what they are worth, they sell for what people think they are worth. Just because you buy stock and get the feeling that you are a shareholder in a company that is generating cash flow doesn’t mean the stock can’t drop 50%.
Let me share with you a story I had with a buddy of mine around November 2008. I knew he traded stocks so I asked him what he was playing. He told me he was buying Citigroup Shares. He told me that with the way the stock dropped from $50 that it was a bargain now. I told him that yeah the selling might be overblown but that when a stock drops 75%+ a large chunk is due to their being legitimate problems with the company. He told me had been buying Citi around the $10 range and been averaging down all the way to $5. I’m like why do you think the company is going to perform well? He told me its going to do good because Citi had $2 trillion in assets or something like that he told me. I’m like you need to also look at their liabilities… I asked him what his exit strategy was and he told me that he was in it for the long run.
Anyways Citi hit $1.00 a share a few months later and has been languishing under $5 for over a year now. I am not sure whether he held through the insane drawdown or cut it loose.
Hope it helps