|
|
Your stock is losing value. You want to sell, but you can't bear to think of selling now before further losses or later when losses may or may not be larger. All you know is that you want to offload your holdings and preserve your capital and to reinvest the money in a more profitable security. In a perfect world, you'd always achieve this aim and sell at the right time. Unfortunately, it isn't that easy in real life. Let's take a look at why selling is important and then talk about a selling strategy that works for any type of investor.
The Breakeven Fallacy
When the dotcom bubble burst in the spring of 2000 and the market started its descent into a bear market, investors froze like deer caught in oncoming headlights. Many didn't even react until the value of their portfolio holdings had declined by as much as 50-60%. (For further reading, see When Fear And Greed Take Over and Basic Investment Objectives.)
There is absolutely no guarantee that a stock will ever come back. In fact, waiting to break even - the point at which profit equals losses - can seriously erode your returns. To demonstrate the importance of cutting losses, the chart below shows the amount a portfolio or security must rise after a drop just to get back to even.
| Percentage Loss |
Percent Rise To Breakeven |
| 10% |
11% |
| 15% |
18% |
| 20% |
25% |
| 25% |
33% |
| 30% |
43% |
| 35% |
54% |
| 40% |
67% |
| 45% |
82% |
| 50% |
100% |
A stock that declines 50% must increase 100% to break even! Think about it in dollar terms: a stock that drops 50% from $10 to $5 ($5/$10 = 50%) must rise by $5, or 100% ($5/$5 = 100%), just to return to the original $10 purchase price. Many investors forget about simple mathematics and take in losses that are greater than they realize. They falsely believe that if a stock drops 20%, it will simply have to rise by that same percentage to break even.
This isn't to say that rebounds never happen. Sometimes a stock has been unfairly pummeled (see Forces That Move Stock Prices). But the long turnaround waiting period (about three to five years) also means the stock is tying up money that could be put to work in a different stock with much better potential. Always think in terms of future potential - you can't do anything about the past, so stop clinging to it! (See Ten Tips For The Successful Long-Term Investor.)
The Best Offense Is a Good Defense
Championship teams have one thing in common - a good defense. This principle can be applied to the stock market as well. You can't win unless you have a predetermined defense strategy to prevent excessive losses. We say "predetermined" because either before or at the time of purchase is the time when you can think most clearly about why you would want to sell. You have no emotional attachment before you buy anything, so a rational decision is likely (see The Importance Of A Profit/Loss Plan). Once we own something, we tend to let emotions such as greed or fear get in the way of good judgment.
An Adaptable Selling Strategy
The classic axiom of investing in stocks is to look for quality companies at the right price. Following this principle makes it easy to understand why there are no simple rules for selling and buying - it rarely comes down to something as easy as a change in price. Investors must also consider the characteristics of the company itself. There are also many different types of investors, such as value or growth on the fundamental analysis side.
|
|
|
|
•