Editor's note: Even in a strong bull market, we can see bumps in the road. You've probably had to sell some stocks now and then. That doesn't have to be the end of the story... But you should only ever buy back with discipline.
In today's Weekend Edition, we're taking a break from our usual fare with a classic piece from MarketWise CEO, Dr. David "Doc" Eifrig. In this article – which we last shared in DailyWealth in November 2023 – he explains the three things you must do before you consider rebuying a stock.
You can do everything right in the investment world and still get burned...
Has this ever happened to you?
You analyzed all the competitors in the industry, you crunched the company's numbers, you paid what seemed like a fair price for the stock... and yet you still took a loss.
The problem was your timing.
Maybe you chose a too-tight stop loss during a market correction... and as a result, you were knocked out of your position before your investment thesis could really take off.
Stop losses exist for a reason. They protect you when you get it wrong. Legendary hedge-fund trader Paul Tudor Jones is known for having a handwritten note above his desk warning that "losers average losers."
But we've all had that one stock we've been stopped out of that we knew we were right about...
Don't Fall Into This Trap
The key mistake to avoid is trying to "catch a falling knife."
As a stock falls, it does get cheaper, but timing bottoms in asset prices is the hardest way to invest. You'll do better by waiting for an upward trend to form and riding that momentum.
Today, we're going to talk about when you should "rebuy" a stock you got stopped out of. Here are some basic guidelines...
No. 1: Wait Six Months
We always recommend using stop losses to determine when to sell. One reason for that is that downtrends can always get worse.
The worst outcome is to stop out of a stock for a loss... rush to buy it right back... and stop out again for another loss.
If you give yourself time to cool off, you can avoid this situation. Your emotions will stay under control. You may miss a buying opportunity now and then. But on balance, this simple rule will serve you well.
No. 2: Wait for Positive Momentum
It's a statistical fact in the markets that stocks with prices that are already rising continue to outperform. Use momentum to your advantage. There are a few simple, tried-and-true ways to measure upward momentum:
- The stock has seen a positive 12-month price change.
- The stock is above its 200-day moving average (200-DMA).
- The stock's 50-DMA is above its 200-DMA.
That may sound complex. But the easiest thing to do is to wait for a new high.
It may seem counterintuitive at first. After all, aren't you supposed to buy stocks when they're on sale? But in these cases, a new high indicates that whatever concerns led to the stock's decline have been alleviated.
And, statistically, the most likely thing for a stock to do after it sets a new high... is to set another new high.
Several academic papers have looked at decades of data to support this theory... One research paper by Thomas J. George and Chuan-Yang Hwang, "The 52-Week High and Momentum Investing," showed that the closer a stock's current price is to its 52-week high, the better it performs in the future.
No. 3: Reexamine the Fundamentals
The final thing you want to do is reexamine the fundamentals. The best time to reenter a stock is when it has proven it can sustain the growth you expect from it. And of course, you want to make sure the stock still trades at a fair valuation. You can use a simple price-to-earnings or price-to-sales ratio to determine this.
In an ideal world, you end up getting a business with more growth and better prospects at the same valuation you previously paid.
Now, we don't recommend reentering every stock you get stopped out of. You should consider this for only your highest-conviction ideas.
At the very least, wait six months, wait for positive momentum, and make sure the fundamentals are still strong.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig
Editor's note: Doc has been using Bloomberg's relative-rotation graph for months to track the momentum of stock market sectors. And on Wednesday, July 15, he's unveiling his own brand-new system that takes this analysis to another level. It tracks the rotation of individual stocks... showing exactly when they enter the "Buy Zone." Don't miss his briefing on this powerful new tool – claim your free prelaunch access now.
