(By Greg Guenthner) You don't have to deal with the emotional pain caused by the meltdown of a speculative investment.
If you learn the two simple market truths I'm about to reveal, you could actually protect your brokerage account from big losses. You'll also know how use these tips to spot a failing investment before you buy shares…
I know how easy it is to get caught up in the story of an exciting company. In fact, nearly every person who has invested a dollar in the stock market has bet on an intriguing story.
Inevitably, most of these stories don't pan out. Whether it's a futuristic technology or even a new source of energy, we've all laid money on a bold speculation that delivered terrible returns. Unfortunately, losing money on what you thought was a sure-thing can be traumatic. You'll find yourself wondering why it went bad. You might even want out of the market for good…
The two market truths I'm revealing today will hopefully put an end to your uncertainty. They don't require an advanced knowledge of economics or finance. And you can apply the tips to virtually any investing situation.
Here's what you need to know…
First, a stock can become "detached" from the company it represents.
What this means is the share price can quickly drop—even if the company in question is releasing favorable news or impressive earnings. A sharp decline in share price on "good news" is one of the most gut-wrenching situations you'll experience when investing. It's frustrating. And it can cause you to think irrationally.
There are countless reasons the stock of a seemingly good company can drop. The company could simply be too early along the development curve to attract more investors. Maybe only a few forward-thinking folks can see the potential that others have yet to grasp.
The truth is, promising companies can have bad weeks or even bad years. You have to prepare for this possibility that your idea might not translate to an obvious investment to the average speculator…
The second market truth you need to remember is that selling won't abruptly stop and turn into buying.
If the market collectively decides to sell a name for any reason, the selling is likely to continue. Rarely will you see a stock reverse course and move higher immediately following a strong selloff. Investors and traders won't want to buy a stock that's exhibiting a strong downtrend—because they think they'll be able to get it cheaper if they wait.
With both of these situations, it's important to identify when sellers are taking control. If the price starts to move lower on high volume, you must act immediately to preserve your capital. After all, you can always wait and buy shares at a lower price if you still believe in the company.
Let's apply this thinking to some reader mail:
I want to ask you about SEFE Inc. (OTC:SEFE)… it appears to be a real company with a working prototype. I am familiar with the electrical potential in the atmosphere they are trying to tap and the idea is basically sound… though I consider SEFE very speculative. Now that the dump is over it might be an opportunity.
Here's a chart of the stock in question:
I don't know anything about the technology, but I can tell you that this stock is not exactly popular right now. It enjoyed an impressive run in April, but the share price has completely tanked since then.
It appears SEFE is trying to find support at 40 cents. But it could very well move lower from here. If you are interested in the company and want to try to get in at a lower price, you should wait to see if the stock holds here at 40 cents, or even tries to move higher. It might take time— but you have to make certain that anyone who bought in May has sold their shares. Anyone who failed to sell at or near the April top is underwater. They might be looking to sell on any move higher…
Remember today's second tip: selling won't abruptly stop and turn into buying. If you remain patient, you will see if and when the stock begins to level out. This will give you a much better chance at finding an ideal entry point.