From our last post, is it risky to buy Exxon at a 52 week low, but after oil prices have fallen 70% and show no signs of recovery?
The answer is: it is a lot less risky than buying the stock at its 52 week high when oil prices are $110 a barrel. It is not risk-less of course, but the lower the price of an asset, the less risky it is to purchase it. For instance, if you were given a gift of Exxon – ie, its price to you was zero – you could not help but make money. You would hardly care where Exxon’s price had been, if you acquired your shares for nothing, which is the ultimate low price.
Investors, however, behave differently. Many investors see stocks that are rising as less risky than stocks that have fallen. This is a behavioral marker of humans: we ‘herd’ together, and if other people like something and bid it up, we feel better joining in.
Another behavior that shows how we feel about risk is reluctance to take losses. Realizing a loss is an admission that you were wrong. But nothing says you have to make back a loss on the same horse that lost for you. Sometimes switching horses is the best move.
Risk mismanagement abounds in the markets; we’ve barely scratched the surface. Yet, the only aspect of your portfolio that you can truly control is its risk. You cannot control return. Obtaining that return at the lowest possible risk is the Holy Grail.