Developing the Proper Mind-Set for Profitable Sales
The hold decision often
results from an investor's bias toward a positive outlook on the future. This subtle bias can persuade investors to take enormous personal, career and financial risks in pursuit of reward.
Investing in the equity market certainly requires a degree of optimism,
but that upward bias must be supported by the fundamentals of the situation, by thoughtful personal judgement and by the judgement of suitable advisors.
It is appropriate for an investor to take some risks in search of the stock that doubles, if that risk is not too high relative to his personal tolerance.
Unfortunately, however, an
investment broker makes a living by catering to this investor optimism, which supports the buy bias described above. So investors lose billions of dollars every year because of the optimism they bring to daily living.
Money is lost not only to fraudulent too-good-to-be-true, get-rich schemes, but also on the buying and holding sides of legitimate securities transactions.
To offset that tendency,
proper buy timing and pricing can help reduce the pressure that inevitably surrounds the selling decision. There is a natural tendency to fall victim to excitement and buy a stock when it is already hot. Only the most disciplined of traders and investors consistently refuse to buy stocks on good news, on stories, or on excited rallies. Instead they demonstrate the self-control to stay with their buy decisions based on their predetermined criteria.
So buying too high on a burst of optimism is the first source of optimism-induced losses for traders and investors. But even greater damage results from holding onto positions because of excessive or unjustified optimism. One major difficulty in overcoming this problem is that declining stocks occasionally do rally.
But an occasional burst of countertrend strength in a weak stock does its die-hard owners more harm than good.
The declining stock, by rallying - sometimes for several days in succession and occasionally by a nice point or more -
provides positive feedback more recently and certainly more often. Each time the stock turns up, a flicker of hope is kindled. The major problem here is that even bad (declining) stocks have their good days (or weeks).
Not only does the daily price action in the market sometimes renew hope, there can be positive fundamental news as well. A good quarterly earnings report or an optimistic brokerage recommendation can generate the renewal of optimism in the heart of an investor. Every plus wiggle in the stock price, every time the price holds steady against a 15-point drop in the Dow and every good piece of news is
a source of positive psychological feedback. Anything that goes right is a vindication of personal judgement.
If the dominant path of the stock is downward, each and every cause for renewed optimism is actually a false signal. In reality, those false signals should be viewed as uninvited distractions from the truth rather than as rays of hope.
When hope springs eternal, the investor must separate the facts of the situation from the fiction. The separation process must include not only the real news background -
what is actually true about the company and its industry versus
what is rumour and hope - but also the psychological environment in which the investor has linked his state of mind with the company and its stock.
Guard against being trapped by a personal, renewed sense of optimism when hope springs eternal.
Using Charts
The best way for an investor to calibrate his state of mind against the market is to rely on stock price charts. Aside from the great debate about the viability of technical analysis, a chart can be useful as an accurate
road map of price movement history.
Without any experience in charting techniques,
an investor can spot whether the stock is still in a downtrend or whether its price action has overcome negative momentum for the better. Only rarely will it be true to say, "I am not sure, it seems to be right at the point of reversing." If that is true, resolve to look again in a week and make a yes/no decision, refusing to take another time extension.
Above all, do not back into a non-decision by default through the insidious process that consultants called
"analysis-paralysis." The market keeps moving with or without an investor. So do not wait open-endedly for just a little more news or technical confirmation. There is never going to be a final answer or a point of total closure.
So exercise discipline: make an evaluation and take action accordingly.
If a stock declines and then rallies, take note of a change in personal optimism level. (How do you feel?) Keep a daily notebook in which to write down the stock's price and the feelings that arise about it; then decide whether the revival of optimism for the stock is justified by the facts. Bear in mind that when a declining stock has rallied back to a given price level, it feels better to the owner than when it had earlier fallen to that same price. The more recent feedback creates hope while the earlier move produced fear.
Watch the emotional difference, even at the same price.
The price an investor pays for a stock can get in the way of prudent selling because it influences the willingness to sell in terms of both timing and price.
So buying well is important but only half of the transaction. The investor also must exit skillfully. Failure to buy well not only puts all the burden on possible net success on the exit execution, but it also colours the holder's thinking in ways that are damaging.
A change of mind soon after a buy is an ego embarrassment because it is an admission of error.
Taking a loss is a second ego blow. So it is evident how the time and price of a badly made by render the selling decision more painful and difficult than it is on a big gainer.
So both the timing aspect of having bought late (recently) and the price aspect of having suffered a loss are dangers to the investor's financial health.
(The truth is that when it is time to sell before the price goes down, it is time for everyone to sell, no matter what the timing is or what the cost at entry.
But human nature seemingly demands that investors factor into the sell decision the stock's initial price. And the less time the stock has been held, the less the investor is willing to
switch mental gears and say "sell.")
What should determine the decision is whether the stock seems likely to go down from here and now; if it does, it should be sold as soon as possible. The central question that should decide the hold/sell dilemma is
"Would I buy this stock today?" Many investors fail to ask that question at all.
There is no denying that buying better helps most investors cash in more effectively when the right time comes. Most buying mistakes (aside from acquiring inflated "hot" new issues and penny stocks) occur not in buying bad stocks but in buying mediocre stocks too late - again, because investors tend to be crowd followers. They wait for confirmation because they need courage. They are most ready to jump in when the market has already become overbought.
If a stock is held only because of perceived positive potentials for the whole market, it should be sold. "Would I buy today?"
A similarly revealing question is whether an investor would sell it here if he had bought better. If there is even a hint of an affirmative answer, he must recognise that cashing in is the right thing to do.
