Ask Colin

How can I know which stocks are going down because of general market sentiment and which ones are going bust?

Almost the only answer I know would be to use relative strength. Relative strength is a widely used and very intuitive indicator. Most charting software will calculate it for you. However, if you do not have charting software, you could find the data on a web site like Yahoo and \d\r\o\p it into a spreadsheet. You can then easily calculate relative strength yourself.

Relative strength = Stock price divided by the Market Index. This yields a ratio. If the value of the ratio is rising, then the stock is stronger than the market. If the ratio is more or less constant, the stock is falling with the market. If the ratio is falling, then the stock is weaker than the market.

It may be tempting to calculate what is called a "point-to-point' relative strength by taking (say) the ratio 12 months ago and the ratio now. However, this is very dangerous. The current ratio could be higher than a year ago, but in that year the ratio has been much higher and is now falling rapidly. You must look at the slope of the relative strength line to make a valid reading.

So that is the best way that I know to do what you want with an indicator. Having answered your question, I now want to question the basic premise of your question. This is that you are holding a stock that is trending down and want to know whether to hold it or sell it in case it goes bust.

The only way you can make a profit by buying shares is if the price goes up. It does not matter how fast the whole market is going down and how slowly your stock is going down, you cannot make a profit from holding a down trending stock. PERIOD.

In my opinion, there is no logic to holding a stock that is trending down. It must be sold immediately you recognize that it is trending down. What you paid for it is irrelevant - you have already lost the money. That you may look silly for buying it in the first place is not relevant - you will look even sillier if it goes bust! What the management says is particularly irrelevant - they always put the best light on it and long experience suggests bad news is followed by more bad news in most cases. What analysts say should be taken with great suspicion, because there are constraints on analysts telling you to sell. The only thing you have that is trustworthy is the price. If the smart money that knows whatever are the "true facts" is selling, then the price will be trending down. You must sell it. You can always buy it back again if it starts trending up, which will happen in a small minority of situations.

It is my strongly held belief that if investors followed this rule alone, they would make fewer, much smaller losses when they get it wrong, which is about half the time even for the best stock pickers.

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