I often interact with traders and investors who are not satisfied with their returns.
They all have one thing in common: they have not been effective salespeople. They hold on to poor stock picks for too long and they don’t take defensive action when the market corrects. They find themselves holding a lot of stocks with significant losses and then wonder what to do.
Digging yourself out of a hole is hard work, and I’ll discuss that in detail in the future, but the best solution is to avoid those holes, and the best way to do that is to use the power of the sell button on your keyboard.
The ability to quickly and easily sell a stock is the most powerful tool you own, but few people fully use it. Selling a stock is generally seen as the last resort after a trade has failed. It is done reluctantly, as it is seen as an admission of failure rather than just part of the trading process
The reality is that selling is your primary source of control over the market beast. It is selling that allows you to reduce risk and develop strategies to position you for big profits.
Often selling is an emotional response, rather than a carefully planned strategy. There is a tendency to view a sale as the end of a trade or an investment, rather than just part of a more complex strategy. I like to see selling as a form of insurance that sometimes temporarily reduces my risk. It can be undone in an instant, and if it incurs any cost, that’s just an insurance policy.
There is often a natural resistance to selling a stock, and the only way to overcome that is to familiarize yourself with the option to buy back shares. I’ve found that when I sell and re-buy a stock that’s bothering me, I feel empowered because it reinforces that sense that I’m ultimately in control of the situation and not the market.
It’s not just small traders and investors struggling with the selling decision. In an academic study entitled “Sell Fast and Buy Slow: Heuristics and Trading Performance of Institutional InvestorsWritten by researchers at the University of Chicago, Carnegie Mellon and MIT, the authors found that professional fund managers would, on average, achieve better returns if they just randomly sell stocks in their portfolios.
“We document a striking pattern: While the investors show clear buying ability, their selling decisions underperform significantly,” they wrote.
The problem is that, as with amateur traders, the pros tend to make emotional decisions when it comes to trading. The first stocks that professional money managers sell are those that have made the biggest strides in either direction. They sell their big losers or their big winners at a price 50% higher than other stocks, as those are the stocks that produce the strongest emotional reactions.
The study concluded that the main reason for this is that managers tend to sell only when forced to do so by market conditions. They don’t have a systematic approach to selling, but generally only make decisions when they have no choice and no strategy.
The best advice I can give is to spend more time on the selling decision and see it as a form of strategy and not just the end of a trade. Do it a lot. Here are some other issues to consider:
- Have a position building strategy that includes regular selling as part of the process. Most traders think that building a position in a stock is nothing more than making incremental purchases. They hold the average and build bigger and bigger positions. That creates a much higher risk, and the position grows and often leads to emotional selling decisions. The better approach is to make some sales as a stock develops and then re-buy as conditions change. The goal is not to let the position be too big when conditions are bad, but to increase it when conditions improve.
- Get more comfortable selling. Many investors try to avoid the sell decision. They see it as a monumental choice rather than something that can be quickly and easily reversed. Just because you sold a stock at a lower price yesterday doesn’t mean you can’t buy it again today. Embrace that way of thinking. With transaction costs close to zero, there’s no reason to hold onto a stock that’s underperforming. Sell it and buy it again when circumstances change. It’s simple and easy, and the more you do it, the easier it gets.
- Randomly significantly reducing positions can be a useful way to reset your emotions and the way you look at the market. It is very beneficial to periodically start with a clean slate as it will significantly change your perception of the market. It’s always surprising how your view of the market will change if you don’t struggle with stocks that aren’t cooperating. You can have a clean boot whenever you want. All you have to do is sell and start over. It costs little to do, and then the emotional benefits can be enormous.
Selling is a great strategic tool. Embrace it and use it often and you will improve your trading and investment results.
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