What should be strategy for stocks fearing Bankruptcy?
hellcome asked:
I have stocks whose price keep falling and I am afraid it might go bankrupt. So there are two things I can do, sell and bear loss or buy more and decrease my average buy price hoping prices will rise again. What features should I calculate about the company to decide whether to buy or sell?
I have stocks whose price keep falling and I am afraid it might go bankrupt. So there are two things I can do, sell and bear loss or buy more and decrease my average buy price hoping prices will rise again. What features should I calculate about the company to decide whether to buy or sell?
That’s a question you can’t just generalize. It requires some research to analize this situation from a balanced perspective.
You will have to read the prospectus of the companies involved, listen to their conference calls, maybe check some forums discussing the company (even though I would personally avoid this), look at graphs from the past (perhaps this can be a cyclical company) and THEN make a decision.
ONLY keep this company if you are able to explain to a newbie who does not know anything about the stock market WHY this company will not get eaten by the bears. If everything points to bankrupt, then you will have to take the pain now or loose ALL your money later.
Time and time again, history has shown that one of the worst mistakes an investor can make is averaging down.
If you want to keep the stock, then consider buying a put option that would allow you to sell it later for the current strike price if the price were to keep falling.
Otherwise, just sell it and take the loss.
If you really feel that they will go bankrupt, then sell and take the pain. Averaging down is just increasing your exposure and your potential losses if your fears become true.
A bankruptcy filing may well drive the price down further. Also, common stock is sometimes cancelled in a bankruptcy reorganization. If that happens, your stock will be worth zero.
One of the most common mistakes that people make is refusing to admit that they’ve made a mistake and cutting their losses.
Use a relative price chart of that stock to the SP500 ($SPX). You can do this on stockcharts. If the 50dema is under the 200dema on this relative price, the stock is bearish. This technique is what I use and it has done me very well.
If a company is at risk of going bankrupt, it means that any investment in the company’s stock is potentially subject to a total loss of capital. For this reason, be very cautious about buying the stock unless you are comfortable with the concept of losing every dollar you put into it or you take steps to protect yourself.
You might be thinking that you’ll short the stock, but the likelihood is that the potential for bankruptcy is already factored into the equation and there won’t be a whole lot of room to fall. You may also find that it is difficult to borrow those shares from your broker and simply may not be able to get short.
Options would allow you to make a direction bet, however. A lot of folks will shy from options, believing that they are risky instruments. The reality is that they are very good tools for taking a position on an otherwise risky situation, like a bankruptcy, while keeping your risk strictly limited.
You can get a few ideas about how you might use options for such a play here:
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