The end of the world, relatively speaking

May 7, 2010 in Finance

Bloomberg has a story today which takes a close look at an Apple investor who was caught in yesterday's turmoil. Apple traded down more than 15% on the day before snapping back to a -4% finish. This particular investor first purchased his 26 shares of Apple in late 2007, for $189. He sold them in a panic for $224, just hours after the stock closed at 255 - and minutes before it would jump to 246. I understand his frustration - to put it bluntly, that sucks.

More interesting to me, from a behavioral finance standpoint, is that this investor felt like he was experiencing "the end of the world" as the bottom fell out without reason and with speed. But let's review his investment's history:

This investor held onto his shares for two years before they were profitable. In the interim he experienced not only a 40% drawdown, but an even bigger 57% drawdown that same year! However, his patience was rewarded with an unusually calm run up to $260... which might be why the relatively minor (though still painful) -17% drawdown of May 6 shocked him into selling and locking in that long term tax gain. The irrationality on display is academically fascinating and practically terrifying.

So why, on a day when a trillion dollars vanished and some stocks traded for a penny, did Bloomberg decide to write about a single investor's $6,000 ultimately-profitable investment? It's the sort of story I'd expect from The Onion! In this publication, however, it's the sort of reporting that encourages exuberance - and reinforces panics - with appeals to emotion and no understanding of context. On the other hand, this investor's experience and thoughts were typical of many people and it is critical to keep that in mind. The article serves its purpose as a reminder of that fact and should drive home the idea that risk is ever-present and the one thing you can be sure of is that it will pop up in the most unexpected way.

(One last thing: the investor now has a limit order to buy AAPL at $195. Because, you know, limit orders had nothing to do with yesterday's price action...)

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