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Knowing When To Sell

There are countless studies that show how investors cling to stocks that have declined, even though they have no confidence that they will recover. Why is that? Considering recent history and how many stocks have recently tanked, trying to answer this question seems especially critical now as you consider your current positions in the market.

How often have you heard from some person at the water cooler, "I will never sell XYZ while I live." XYZ is of course a fictitious stock. How about, “I rode it down, I mind as well stay to ride it back up.” You probably have heard something similar more times than you’d want. Me too.

What troubles me about these types of comments is that these investors have, for the most part, lost touch with the principles of prudent investing. If I were mean, I would have said they had lost touch with reality. But I’m not. So I won’t.

The problem is that these types of investors are holding firmly on merely because after taking a horrible loss they are waiting, hoping, that the stock will rebound to the price at which they bought it so they can sell without incurring a loss. This is, unfortunately, a terrible and costly mistake. And very common too.

  • The Known vs. The Unknown

In a paper published out of the University of California at Berkeley by Terrence Odean titled “Are Investors Reluctant to Realize Their Losses?” ( he discussed how investors realize their gains more readily than their losses by a margin of two to one. This means investors are two times more likely to sell winning stocks than they are to sell stocks that lost big. Furthermore, he pointed out that most of the winners that were sold to cover losses went on to outperform the losers that investors kept.

People are generally risk-adverse, making them extremely cautious when it comes to an unknown factor like a stock’s growth. A loss is a known value. I lost $17.91. I will be happy when I regain that $17.91. The concrete nature of that number allows investors to sit on the loss because they have a benchmark they need to attain. A gain on the other hand is an unknown factor. My stock went up 10%. Then lost 5%. Then gained another 15%. Do I sell now? What if it drops tomorrow? This is the type of uncertainty that makes people uncomfortable. So they sell winning stocks after only realizing a small amount of gain and miss out on the big gains down the road.

Losing money is a painful thing that can trigger irrational, cataclysmic decisions, especially among less experienced investors. Many of us can still feel the pain or are still suffering the consequences that resulted from our euphoric exuberance from several years ago. The uncertainty, fear and even panic that overcame many of us had a freezing effect on us. That inability to act during what was an absolutely critical time cannot be allowed to happen again. It is essential that when similar times return, investors act rationally when making investment decisions.

  • The Ego of Investing

Despite what some people claim, even the best and most successful investors make mistakes. What differentiates them from the rest of the pack is that they research stocks to death and thus make fewer mistakes. And equally importantly, they quickly recognize, acknowledge, and sell off when they do make mistakes. It seems only natural that when you realize you made a mistake you fix it, usually by selling. But you would be amazed how often this is not the case, especially when it entails selling at a loss.

It has to do with the ego in all of us. Nobody likes to admit to himself that he was wrong. Nobody wants to take that long look in the mirror. If we made a mistake in buying a stock but can sell it for even a minor profit we feel smart and self assured. But if we take a loss, we feel sheepish and angry at ourselves for our mistake. This is only natural but it has the possibility to be extremely destructive to investments. It promotes investing according to emotional whims, rather than cold, calculated thinking.

Remember, more money has probably been lost by investors holding a stock they really did not want until they could at least break even than from any other single reason. If you can avoid this snare, you will be better off than the vast majority of investors. Remember again, the enemy of successful investing is emotion.

  • Cold, Calculated Thinking

Understanding that human nature makes it difficult to sell losing stocks is the first step in removing that irrational feeling from your decision-making process. Try this. Take a sheet of paper. Now imagine the value of all of your stocks to be cash. And if you could buy anything what would you buy? How would you invest this cash today? Write those things down on your piece of paper.

Now compare this made-up portfolio to what you really own. Is it radically different? If there are any stocks you currently own that you would not buy today consider the reasons. If you’re waiting for a recovery, sell it. If there is a good reason to keep a stock, such as a large capital gain, then make your decision after considering all your options and the implications. If you don’t know the answer than ask someone, like your broker, for help.

When you are holding onto a losing stock, don’t forget to consider this one bit of information that should make the decision to sell easier. You can get the IRS to pay you for selling a losing stock! That’s right! Mind you, this is an oversimplification, but the general idea is right. Ask your broker for specifics. Regardless, this should help ease the pain of selling a loser.

The world turns everyday. So, too, does the market. When companies and industries are subjected to the bizarre ebbs, flows, and crosscurrents of business, they change. New information surfaces, washing away assumptions, making your stocks decline—usually for a good reason. The key is to recognize whether your hard-earned money should be elsewhere by figuring out which stocks are mistakes and which represent opportunity. That's not easy, but it is certainly much easier if you can overcome our basic human nature to irrationality cling to losing stocks.