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Actions to Take When a Stock Price Declines


There are numerous reasons why a stock's price falls and it is up to you as a stock investor to determine the cause. By identifying why the price is falling, you are far better equipped to decide if it is time to sell your stock position or if the fall in value presents an opportunity to purchase additional shares of a stock. The key is neither to react every time a stock you own dips, nor to become so emotionally attached to an investment; the decision to sell a stock should be similar to the decision to buy a stock. But the price paid for a stock must be put aside when deciding if it is time to sell. The sell decision should focus on a company's potential prospects and fundamentals relative to its current stock price. If the reasons for buying the company—i.e., its fundamentals have not changed, then there may be no reason to sell. Many investors lose sight of this and allow their emotions to dictate their sell decisions. When you look at stocks that are declining in price, often you will find recurring themes that, once identified, can help you decide what your next step should be.

Market Weakness

Weakness in the overall stock market, by itself, is never a good reason to sell your stocks. Markets rise and fall, but history has shown that over the long term a well-diversified portfolio of stocks will not only generate a positive return, but also provide the best chance for providing a return above the rate of inflation. It is a good idea, however, to compare the performance of an individual stock to that of the overall stock market. One of the main goals of any stock investing strategy is to achieve returns above those of the overall market for a given level of risk. Most stocks react to market moves in a consistent pattern. Further investigation is warranted if the price movement of a stock suddenly starts to deviate from its past relationship with the stock market or related index. Even if the company appears to be in the same condition as it was when you bought it, a lagging stock price in relation to the overall stock market may mean that there are investors that believe that the stock's fundamentals have changed. In this situation, you might consider selling your position instead of waiting for information to surface.

Stock Prices and Industry Cycles

All industries, to some extent, have a pattern to their movement. Most industries follow a seasonal pattern, with sales stronger in some portion of the year. Economic cycles are even more pronounced and longer lasting. Some industries move in tandem with the economy—rising as the economy expands and falling when it contracts—while others are counter-cyclical, meaning they move in the opposite direction of the economy as a whole. No matter what the cycle, you should not sell a stock investment just because its industry has entered into the decline portion of a cycle. As a long-term investor, you should be aware of any cyclical behavior in a stock's industry before you buy the stock, and you should be prepared to hold the stock through the upward as well as the downward portions of the cycle. Just as the market as a whole can have a bearing on an individual stock's price, so too can the industry in which the firm operates. A downturn in a stock can be attributed to the cyclical nature of its industry, a long-term secular trend, structural weakness within the industry, government regulation of the industry, or liability issues facing the industry.

Structural Changes in an Industry

There are times when a decline in the overall industry signals a time for you to sell your shares. One such example involves structural changes within the industry. Structural considerations, as the name implies, strike at the very heart of the industry and ultimately can determine its survival or failure. Structural changes can be brought about by several things, including technology and competition. Companies within industries faced with structural changes will more than likely see some change in their fundamentals. The extent of the impact, as well as the industry's and company's ability to adapt, will determine whether the time has come to sell.

Competitor Announcements

Companies do not operate in a vacuum, and what happens to one company can impact those around them, especially those that are competitors. Announcements from a company that deal with overall industry conditions will, to some extent, have an impact on its competitors. When a company issues a warning regarding its operations, the first thing an investor should do is discern if the problem is unique to the company or is an industry-wide problem. Bad news that points to a weakness in the overall market or industry does not bode well for other companies that are in a similar industry.

Maintaining your objectivity during these times is important to your investing success. Unfortunately, there are no simple, mechanical rules that are effective for when to sell a stock. Nothing substitutes for an understanding of what economic, industry, and firm fundamentals drive your stock's price. By examining the situation rationally and doing your homework to determine if the fundamentals of the company have changed, you are better equipped to determine whether the time has come to sell your stock.