The funny thing about buying stocks is that it may seem like you’re making progress, it may seem that your portfolio overall is appreciating in value over time. Unfortunately, if you look at the big picture and you focus on the forest as a whole, it is very easy to lose sight of the fact that some of the trees are very sick. It’s very easy to lose sight of the fact that some of your stock picks aren’t really all that good and as a result, you lose money.
Now, again, your portfolio is going up in value, how can you lose money in this context? Well, it’s easy to lose money if you factor in opportunity costs. Instead of picking that stock that tracks sideways or gains a value that is a fraction of the rest of the market, what if you put that money you invested in that stock into another stock? What if you put it in a growth stock that is shooting up like a rocket? Compare the difference. This is your opportunity cost. That’s how you lose out.
So how do you know if you are buying the wrong types of stocks? Here are 7 ways to figure this out.
The Stock is Trading Sideways with No Immediate Prospects of Upward Movement
You have to remember that time is money. That was true in the past, that’s true now, and will continue to be true long into the future. If you’re buying stock that is not really doing much of anything except trading sideways with a small upward tick every once in a while, you’re wasting money because you could have invested the cash that you put in that position in another company that at least tracks the market. If the market is going up 2%, then your money is going up 2%. Compare that with a stock that basically is just stuck in position trading sideways.
You Bought at Too High a P/E
Another way you can determine whether you bought the wrong stock is if you got in at too high of a P/E ratio. This is a dead giveaway. After all, you’re buying at a price that far outstrips its earning capacity. You’re buying at the top.
But this might not be all that bad. Assuming that the stock is really popular and is part of a trend or a lot of analysts are crazy over the stock, you might actually have bought in at a bargain. It really all depends on the context of the stock. But normally, a high P/E ratio is a red flag. You have to look at the context.
Stock is Moving Downward at High Volumes
If you notice that a stock value is dropping significantly and the volume of shares changing hands is picking up or is at a very high level, you have a serious problem on your hands. You have to make a big decision. You have to either abandon the stock completely or come up with other plans.
One approach would be to get out of the stock. And if the downward pressure continues, start shorting the stock. In other words, whatever value you lost on the way down, you make up as the stock continues to crash.
Now, of course, the stock can easily hit its trading floor and refuse to sink any further. The worst case scenario, of course, is that it bounces right back after you shorted it. Still, when you notice that one of the stocks that you bought is moving downward at high volumes, this is not the time to sit back and hope and wish things would improve. That’s not a winning strategy. You need to step up and take action. You need to be proactive.
Heavy Selling Volume From Insiders
Another sign that you bought a wrong stock is when the insiders of the company itself, like its CEO, founders, and what have you, have started dumping the stock. This usually happens with companies that just went through their initial public offering. So when that happens, don’t be too alarmed unless there are other things happening in the company. It’s just to be expected that when people founded the company that they would want to cash out at some level or another. That’s okay.
But if you notice that they’re cashing out at high levels, and this is way after the IPO and the company is not making money or is losing money, then this is a red flag. In this case, you need to, again, exit the stock and then start shorting it because nothing shows lack of confidence more than the actual insiders of the company dumping the company’s stock. They’re in the best position to know. And the fact that they’re behaving that way means that the company’s prospects probably aren’t all that bright.
Priced Over Consensus for an Extended Period of Time
If the stock has been priced over the consensus price for it for an extended period of time, it may be susceptible to marketplace gravity sooner rather than later. In other words, it has defied the market’s expectations for so long. It’s only a matter of time until that downward pressure will catch up to it.
You don’t want to be caught holding an empty bag. So if you have already generated a bit of profit with such a stock, the fact that it’s been priced over its consensus price range over a long period of time, should be enough to push you to exit until the price lines up with consensus.
Of course, this can work against you. The consensus might change to be reflected up instead of the price going down. But still, there’s something going on with the stock if it’s able to do this for a long period of time.
Weak Product Pipeline
This is a fundamental and analytical approach. When you look at a stock and you notice that it really doesn’t have any breakthrough products in the pipeline, that stock may be in trouble. This analysis is especially appropriate for pharmaceutical companies which are sensitive to product pipeline issues.
If a company, for example, like Pfizer, doesn’t have any breakthrough products in its short term or medium term pipelines and it hasn’t bought a company that has such a product, you might want to think twice about either buying the company or staying in it. It’s only a matter of time until it starts hitting the skids because it won’t be able to keep up its sales volume because there’s no breakthrough or new product available.
Maturing Market and the Stock as a Secondary Player
If you bought a stock in an industry that has seen better days, you better bet on the top player of that industry. If you made the mistake of buying a secondary player, right now its stock may not be crashing. It may be stuck trading sideways, but it may not have hit the skids. There is no better time than now to start reconsidering your position in that stock.
This company is a secondary player. It doesn’t own that market. It’s just playing second fiddle. So consider exiting and finding a better play.
Keep the 7 signs above in mind if you’re still unclear of whether you should hang on to a particular stock or not. You need to filter all your stocks proactively all the time. Otherwise, it’s too easy to end up holding an empty bag. It’s too easy to get burned. Consider yourself warned if you see any of these signs.
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