Or, if youre a real optimist: a stock that drops like a rock will bounce back tomorrow or soon.
In either case, investors lock their minds into concluding the movement in some direction of a stock sets its course for the future.
Buying StockThis explains why they have no problem buying a stock that has just run up 45 percent and assuming it will keep growing at that rate forever.
Investors read about a stocks rapid rise and want in on the action. Unfortunately, if they dont do their homework they may not know that the stock has been run up way past its intrinsic value and it set up for a major sell-off as investors who got in early take their profits and run.
A stock that shows a period of rapid growth seldom maintains that same rate for an extended period. If the stock is pumped by the rapid growth of the company, it may be hard for the company to continue at the same pace. The larger the company gets, the harder it is to grow the company by significant percentage increases.
Selling StockThis mindset also explains why investors dump a stock at the first bad quarter or dip in stock price the stock must surely be headed downhill forever.
If you dont know the companys business, it is easy to get spooked when a few bad numbers show up on quarterly reports. However, if you know something about the company, youll understand the numbers better and be able to decide whether a poor quarter is just a bad quarter or the beginning of bigger troubles. One bad quarter is usually not a reason to dump a quality stock.
However, you dont want to be blinded to a companys faults. If the company has significant problems that dont seem to be addressed by the management, you shouldnt hold on with the hopes that things are going the change. Companies do pull out of tough spots, but you need to be realistic about those chances of it happening.