The first thing to keep in mind is that any stock trading under $5 should first be treated as a bankruptcy candidate. Usually there's a compelling reason why stocks fall under $5 a share, and all sorts of negatives are triggered. Many brokers do not allow low-priced stocks to be sold on margin. In turn, some investors will need to liquidate shares, add more money or a combination of both.
Many funds won't consider stocks under $5 (with good reason), and the likelihood of finding a stock that falls below $5 on an analyst upgrade list is about as high as my ability to log into Facebook without countless annoying invites to play "Bubble Safari" or some other online game.
The next thing that investors want to keep in mind is that a strong first move is usually the right move. When stocks implode from damaging news, quick sellers leave because they fear a trend continuation. Zynga has many shareholders who are mentally coming to grips with the fact their investment is worth 20% less today than it was only a few days ago.
Many are on the fence trying to determine if they should remain and hope for the best, or exit now to avoid the possibility of further losses. You might be one of them. Sometimes taking a painful but relatively small loss is the right choice. In the trading world there is an old saying: Your first loss is your best loss.
What that means is doubling up to reduce your average cost and/or "hoping" for a quick comeback usually results in even greater losses. When the market is telling you that you're wrong, it's generally appropriate to listen.
The key is to evaluate what the market is saying with what the financial reports are saying. Take Apple , for example. Apple is down significantly from a high of over $700 per share, but appreciated each of the last four years. With half a year to go, Apple can still end higher for 2013.
Even if Apple doesn't technically close higher, Apple has a strong dividend that pays shareholders to sit on their hands. Zynga isn't considering a dividend, much less paying one. Speaking of "your first loss is your best loss" and sitting on your hands, take a look at the negative response I received when I warned investors a year ago about Zynga.
I wrote "Buy Apple and Google, Wait On Facebook, Stay Away From Zynga" over a year ago. Take a look at the comments. You can easily tell who read the article and had an emotional reaction. At that time, Zynga was trading for more than double the current price.
Those who took action to protect their portfolio are clearly in much better shape today than those that dug their heels in and refused to recognize the reality of the situation.
We're not talking about simple volatility either. Zynga hasn't traded north of $7 since. It may feel good to kill the messenger, and you're welcome to post your comments below, but that's all I am, just a messenger reporting what I see.
I won't leave you without an entry price. After all, just because a stock is beat up doesn't mean you can't make money from it. I wrote several articles about oversold stocks including this one about RadioShack when it was all but given up for dead.
RadioShack has almost doubled since then, but the key is not paying too much or having to wait too long. Look for Zynga to test $2 a share again. Then look to enter (with only highly speculative capital you're comfortable losing) at $1.91 a share.
If you can buy for less than $2 a share, you can consider the investment the same as an option purchase without an expiration date. The odds won't be in your favor but if it makes it through to the other side, you may have a double or more. Just be sure to take some gains off the table if it does pop higher in case it quickly falls back again.
At the time of publication the author had no position in any of the stocks mentioned.
This article was written by an independent contributor, separate from TheStreet's regular news coverage.