I often interact with traders and investors who are unhappy with their returns.
They all tend to have one thing in common: They have not been effective sellers. They hold onto bad stock picks for too long, and they fail to take defensive action when the market is correcting. They find themselves holding many stocks with substantial losses and then wonder what they should do.
Digging yourself out of a hole is hard work, and I'll be discussing that in great detail in the future, but the best solution is to avoid those holes, and the best way to do that is to harness the power of the sell button on your keyboard.
The ability to quickly and easily sell a stock is the most powerful tool that you possess, but very few folks use it to its full capacity. Selling a stock is generally viewed as the last resort after a trade has failed. It is done grudgingly, because it is viewed as an admission of failure rather than just a 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 cut risk and develop strategies to put you in a position for big gains.
Often selling is an emotional reaction, rather than a carefully planned strategy. There is a tendency to think of a sale as the end of a trade or an investment, rather than just part of a more complex strategy. I like to think of selling as a form of insurance at times that temporarily reduces my risk. It can be undone in a second, and if it carried some cost, that is just an insurance policy.
There is often a natural resistance to selling a stock, and the only way to overcome that is to grow comfortable with the ability to buy back stock. I have found that when I sell and rebuy a stock that is bothering me, I feel empowered, because it reinforces that feeling that, ultimately, I am in control of the situation and not the market.
It isn't just small traders and investors that struggle with the selling decision. In an academic study entitled "Selling Fast and Buying Slow: Heuristics and Trading Performance of Institutional Investors," written by researchers from the University of Chicago, Carnegie Mellon, and MIT, the authors found that, on average, professional fund managers would produce better returns if they simply sold stocks in their portfolios at random.
"We document a striking pattern: while the investors display clear skill in buying, their selling decisions underperform substantially," they wrote.
The problem is that, just like 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 moves in either direction. They sell their big losers or their big gainers at a 50% higher rate than other stocks, since those are the stocks that produce the strongest emotional responses.
The study concluded that the main reason for this is that managers tend to sell only when they are forced to due to market conditions. They do not have a systematic approach to selling but generally make the decisions only when they have no choice, and there is no longer a strategy at work.
The best advice I can give is to spend more time on the selling decision and think of it as a form of strategy and not just the end of a transaction. Do it a lot. Here are some other issues to consider:
- Have a strategy for building positions that includes regular selling as part of the process. Most traders think of building a position in a stock to be nothing more than making incremental buys. They keep average in and build bigger and bigger positions. That creases much higher risk, and the position grows and often leads to emotional sell decisions. The better approach is to make some sales as a stock develops and then rebuy as conditions change. The goal is not to let the position be too large when conditions are poor, but then to ramp it up when conditions improve.
- Become More Comfortable with Selling. Many investors try to avoid the selling decision. They view 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 rebuy it today. Embrace that form of thinking. With transaction costs close to zero, there is no reason to hold on to a stock that is acting poorly. Sell it and then rebuy it when conditions change. It is simple and easy, and the more often that you do it, the easier it becomes.
- Substantially reducing positions on a random basis can be a helpful way to reset your emotions and the way you view the market. It is quite beneficial to start with a clean slate periodically, as it will alter your perception of the market substantially. It is always surprising how your view of the market will shift when you aren't wrestling with stocks that aren't cooperating. You can have a clean start anytime you want. All you need to do is sell and start again. There is little cost to doing it, and then the emotional benefits can be tremendous.
Selling is a tremendous strategic tool. Embrace it and use it often, and you will improve your trading and investing results.
