Stand Firm When Your Shares Take a Hit

This is Part 1 of a two-part article.

Get inside the mind of the average investor, and you're in for wild and crazy ride. Metaphors like "the glass is half-full" or "the glass is half-empty" don't apply -- they're too tame. When the glass is brimming to overflowing, investors see it as empty. And when the glass is empty, investors cradle it with care so they don't spill the contents.

The up-is-down, down-is-up mind-set of the typical investor is evident in this example: An investor figures that Whirlpool (WHR - commentary - Cramer's Take) is worth $120 per share. (Note: My calculations indicate a higher value.) The investor pays $90 per share for the stock and happily imagines taking a $30 profit when the price eventually migrates to fair value. Then the investor watches the stock quote fall from $90 to $80 to $70, and then to $60. The price drop is proof, to this investor, that he made a mistake. So he sells the stock.

It's a dumb move. If there is no long-term impairment to Whirlpool's value, it's dumb to sell the stock just because the price quote has dropped.

Investors make dumb moves in the stock market with regularity. It's not because of a lack of intelligence, a lack of effort or a lack of attention. The proximate cause of dumb moves is a lack of understanding. You can't play a game of strategy if you don't understand the game.

Here is a foundational formula for investing in the stock market. Investors suffer significant capital destruction when they act in contravention to this rule. Memorize it. Imprint it into your memory. It might prevent you from making a dumb move in the market.

Here's the short version: Absent a material change to the business, as price declines, risk declines, and your anticipated rate of return increases.

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At time of publication, Alsin and/or ACM was long Whirlpool, although holdings can change at any time.

Arne Alsin is the founder and principal of Alsin Capital Management, an California-based investment advisor. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback; click here to send him an email.