Jason Zweigâs latest column at the WSJ (Psyching Yourself Up to Let Losers Go ) tackles a tough issue for most investors - when to sell. Selling can be difficult for a variety of reasons, but a big factor is psychology. We donât like to let go and give up things weâve bought. Zweig provides us with a telling statistic:
Individual and professional investors alike struggle with selling. Berkeley finance professor Terrance Odean has found that investors are at least 50% more likely to sell their winners than their losers. Among the money managers surveyed by Cabot Research, a Boston consulting firm, fewer than 30% base their sell decisions on âextensive research.â The rest concede they basically sell by the seat of their pants.
To defend our portfolios from our emotions, Zweig offers us six techniques.
1. Use stop-loss orders
Iâve never been a fan of using a stop-loss order on a companyâs stock. I know that Investors Business Daily advocates the use of selling whenever a company falls 10% and I think itâs too trivial of a rule. Zweig says that he doesnât advocate the use of stop losses but prefers âstop lookâ orders:
Whenever a stock drops, say, 25% below what you paid, automatically review your original top three reasons for buying to see whether they are still valid. That will prevent you from selling without thinking first.
This is a pretty good idea. I practice the same kind of exercise myself. I donât have any alerts set to tell me when about a drop of 25%, but I do check my companyâs prices regularly. An easy way to get notified of drops in your companies can be done with Yahoo Alerts, you can get an e-mail or text message based up requirements you set (price drop/rise or percent drop/rise). Two of my holdings, Air Transport Services Group (NASDAQ: ATSG) and Steak N Shake (NYSE: SNS) have fallen a bit from my initial buying points ($1.70 and $10.00).
In each of these cases, I re-analyzed my investment thesis, to see if anything changed. With ATSG, the fall from $1.70 to below $1.00 was triggered by almost no news. DHL severing business ties with ATSG was already part of my investment idea- so I didnât see a reason to sell. With SNS, my thesis hinged on Sardar Biglari getting onto the board and gaining control so that he could make the right decisions for the company. I decided that I would not sell till that thesis was properly tested.
2. Donât Go Far Afield
Here, Zweig recommends buying an industry index if the company you purchased ends up having poor results. I donât quite agree with this advice. It all seems a little bit like decisions made by an investor who doesnât know what theyâre doing who is trying to catch a trend (and may be too late).
The only time I think that this is valid is when youâre investing in an industry with good economics but where the individual players might be too hard to pick. Iâm thinking of Buffettâs investments in pharma with companies like Sanofi Aventis (NYSE: SNY), GlaxoSmithKline (NYSE: GSK), and Johnson & Johnson (NYSE: JNJ). The difference with Buffettâs investments in pharmaceutical companies is that he still was not buying an ETF, he bought just a few of the players in that industry. An ETF will usually have many more holdings and carry the risk of over diversification.
3. Shop Before You Drop
Zweigâs next technique is a bit better-
Ask yourself: Which stock or fund would I most like to own? Then view your losers as a source of funding to reduce the amount of cash you would otherwise need to raise
Sometimes I think that selling losers can be good, especially if youâre purchasing a better buy. Maybe a new opportunity has presented itself with a higher return or the margin of safety in your losing investment has narrowed.
4. Re-price it.
Here, the idea is to take your original purchase price and divide it by 10 and compare that price with its current price. A simpler method might be to look at the price youâre seeing right now and compare it to your conservative estimate for the companyâs margin of safety(the spread between the current price and the companyâs intrinsic value you in your eyes). If youâre buying companies at what you think are 50% discounts, youâll see a wider margin of safety. It will then be up to you to decide if anything has changed.
If the margin of safety has narrowed to a point where maybe the capital could be better used elsewhere, then you should.
5. Follow your sales.
This is some of the best advice in the column.
Using an online portfolio tracker, monitor the returns of all the stocks you sell after you sell them. Studying the aftermath of your mistakes will enable you to learn which you sold too soon and which too late. You cannot improve what you do not measure.
I try to do the same. On my Google Finance page I keep all of my stocks, even after selling them. I like to see what theyâre currently doing and learn from my mistakes and the companyâs mistakes. By doing this, you expand your circle of competence. It makes me think of a quote from Edward Lampert in Fortune Magazine.
[The] idea of anticipation is key to investing and to business generally. You canât wait for an opportunity to become obvious. You have to think, âHereâs what other people and companies have done under certain circumstances. Now, under these new circumstances, how is this management likely to behave?â The plays my father designed for me helped me learn to think ahead. Lots of days I asked him, âWhy canât we just invite kids over and play a game?â In order to do something well, he explained, you have to keep practicing and preparing.
And I think thatâs one of the more important concepts to keep in mind when investing. You can often draw upon past experiences when making future decisions. The situation might not be entirely the same, but itâs incredibly useful to have that kind of knowledge filed away for future reference.
Courtesy: StreetCapitalist.com
