What To Do When Stock Prices Fall: The Paradox of Investing Explained

Updated November 2025

Understanding Why Price Drops Feel Riskier Than They Are

Risk aversion is the fear of irreversible loss - not temporary volatility. The academic literature is crystal clear on this point.

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Nobel Prize winner Eugene Fama’s work (efficient markets, rational expectations, long-run equity premiums) shows that price drops do not predict higher short-term risk of permanent loss unless fundamentals have changed.

Yet behavioural finance (Thaler, Kahneman– pick your favourite culprit) shows that investors experience a loss two to three times more painfully than an equivalent gain. That’s why a modest dip in a long-term holding feels like an existential crisis.

Jim Simons solved this by eliminating emotion entirely. Warren Buffett solved it by anchoring every decision to intrinsic value, not price screens.

The result: three very different instincts. Only one is usually correct.

What Each Strategy Really Means

Here is the table that cuts through the mythology.

Scenario when Stock Falls	Action	When It Is Rational	Academic Backing	Wisdom from Buffett, Simons, Fama
1. Sell	Exit the position	Fundamentals deteriorate, thesis broken, or superior opportunity arises. If the decline reflects permanent impairment, not volatility.	Fama-French research: expected returns only improve if risk factors improve, not because price fell. If earnings outlook collapses, selling is rational. (https://www.nber.org/papers/w10652)	Buffett: “When you find yourself in a chronically leaking boat, energy devoted to changing vessels is more productive than energy devoted to patching leaks.” Simons: Sell when the signals break. No emotion.
2. Hold	Do nothing	When the long-term thesis is intact, valuation is still justified, and decline is within expected volatility bands.	Bogle’s and Fama’s long-horizon data: time-in-market beats timing; volatility is noise, not information.	Buffett: “The stock market is designed to transfer money from the impatient to the patient.” Fama: prices incorporate all known info – if nothing changed in fundamentals, holding is optimal.
3. Buy More (Averaging Down)	Increase position	Only when you are certain: (1) the business fundamentals remain strong, (2) your original valuation case is intact, and (3) you are not exceeding your risk limits. This is not an emotional reaction – it’s a valuation decision.	Academic work on mean reversion in valuations (Asness, AQR) shows that buying cheap can increase future expected returns if the asset is fundamentally sound.	Buffett: “If you liked it at $50, you should love it at $40 – assuming the business hasn’t changed.” Simons: Only buy more if the model says so; intuition is irrelevant.

How To Resolve the Paradox

A risk-averse investor must avoid the illusion that “selling = safety” and “holding = doing nothing.” Risk aversion, properly understood, is the avoidance of permanent capital loss, not the avoidance of volatility.

The Correct Decision Tree

1. Has the fundamental business case deteriorated?

   • Yes → Sell.

   • No → Go to 2.
     

2. Is the volatility within historical drawdown norms for this stock/factor?

   • Yes → Hold (you’re being paid a premium precisely for tolerating this).

   • No → Go to 3.
     

3. Has valuation genuinely improved and are you still within your risk budget?

   • Yes → Buy more.

   • No → Hold.

What Buffett, Simons and Fama Agree On

It’s rare these three agree on anything, but on this point they do:

• Price drops aren’t a reason to sell. Fundamentals are.
  

• Volatility is not risk. Permanent impairment is.
  

• The best long-term returns come from owning undervalued, high-quality businesses through drawdowns.
  

• Buying more is only wise when emotion is absent and valuation work is solid.

Simons would say: “Your model knows more than your gut.”

Buffett would say: “Be greedy when others are fearful - selectively.”

Fama would say: “Markets are noisy; ignore the noise.”

The Takeaway

A falling stock is not a question of bravery. It’s a question of diagnosis.

Selling is correct when the story is broken.Holding is correct when the business is fine. Buying more is correct only when you’re rational, not reactive.

Disclaimer: This article is for educational purposes only and does not constitute financial advice. Investing involves risk, including the potential loss of capital. Always conduct your own research or consult a qualified professional before making investment decisions.

Alpesh Patel OBE

www.campaignforamillion.com