Every day another stock bites the dust. An earnings miss (recently MMM), a guide down (recently Starbucks), the CEO gets fired (recently Wynn Resorts), Amazon gets into another company's business (recently banged up Walgreen's and CVS), a tariff is announced (recently hit Harley Davidson) and the list of reasons goes on.
And just like that, POOF! One of your stocks lands on the biggest loser of the day list. It's talked about endlessly all over financial news. Well, it's happened to all of us and it's bound to happen again. But what do you do when, not if, this happens to one of your stocks?
In the heat of the moment, when something intense happens and you've got your eye on ten other things at the same time, you need a simple diagnostic strategy. Why simple? The idea is to eliminate as many variables as possible so you could make a decision. You could add back variables once the most intense part of the moment passes, but you can't let paralysis from analysis get in your way. This calls for a "decision tree".
I borrowed this strategy from a book called "Blink: The Power of Thinking Without Thinking" by Malcolm Gladwell. In it, he writes about a hospital administrator named Brendan Reilly who was faced with cost overruns and a lack of beds at the low income, Chicago-area hospital where he worked. Patients, many of whom lacked health insurance and who were experiencing chest pain, were coming to his hospital. Reilly needed a quick, cost effective way for doctors to diagnose whether or not these patients' chest pain was from a heart attack, because not all those who experience chest pain are actually having a heart attack. Running a battery of expensive diagnostic tests for each and every chest pain incident was something that was literally putting the hospital out of business.
His solution was to use a decision tree developed by U.S. Navy cardiologist Lee Goldman. Goldman developed a super simple way to help doctors on submarines determine if a crew member's chest pain was from a heart attack or not so that doctors could better decide if the sub needed to resurface, potentially exposing its position. The idea of Reilly adopting this decision tree for his hospital was at first thought of as a bad idea; that it would result in an increase in patient deaths. But it turned out that the success of this decision tree was undeniable.
Why? Because it was simple and gave doctors a solid first impression. Psychologists found that expensive medical tests would make the doctors feel more confident about their treatment decisions for patients experiencing chest pain, but the extra tests didn't improve outcomes. The point of this is to make the diagnosis steps as streamlined and simple as possible. Here is Goldman's decision tree:
Now, I'll bring this back to my own decision tree for when a stock gets clobbered. Sorry about my lousy handwriting. Disclaimer: This decision tree is a work in progress. This is best suited for the individual stock part of a portfolio and is not intended for long term holdings, but could be used in determining when to scale back a long term position or initiate a new position, which is how I use it. It also helps me to differentiate between a value stock and a value trap. Feel free to adjust to your style.
I certainly wouldn't compare what I do to a life and death situation, but we all have to learn how to handle pressure in our career. This works for me and more importantly, for my clients' portfolios. What works for you? Do you have a decision tree that you use? I'd love to see it.
The "QUEEN: Bohemian Rhapsody" movie trailer looks awesome (another one bites the dust). Watch it here:
