GuruFocus Premium Membership

Serving Intelligent Investors since 2004. Only 96 cents a day.

Free Trial

Free 7-day Trial
All Articles and Columns »

Why do we sell low and buy high

May 06, 2007
Amir Avitzur

Amir Avitzur

3 followers
Why do we sell low and buy high? Part I



We’re often told that in order to be a successful investor one needs to buy stock at a low price and sell it at a higher price. If you can do that multiple times, you are destined to be rich. Why is it then that so many of us do the exact opposite?


My intention in this article is to have us open our minds and address some key questions we seldom ask ourselves. Reflect upon your answers and consider what they reveal about you as an investor.

Which of the following traits apply to you a few minutes/days before you purchased a stock or shares of a mutual fund?

• I read a great story about the company and it said that now is the time to act

• My friend told me she made 100% return on a stock and I asked myself, “why her?”

• The markets are breaking new highs every other day and I felt left out.

• I read yet another story about the urgent need to plan for retirement.

• I learned through a seminar that the only way to make money these days is through the stock market.

Which of the following traits apply to you a few minutes/days before you sold a stock or shares of a mutual fund?

• I read in the paper today that the economy is going to tank, oil prices are going to skyrocket, and the consumers will have no money left.

• My friend told me that he now sits on the fence after making “a lot” of money selling his stocks.

• My stock just dropped another 5% on top of the 20% it already lost.

• I read yet another story about the urgent need to plan for retirement.

• I learned through a seminar that the only way to make money these days is to buy gold/silver, purchase a vacation house/second condo, or collect art.

Do any of the above sound familiar? How many times have you asked yourself, “Why did I buy this stock in the first place?” or “Why can’t I make money like Joe?”

As humans, we are driven by several psychological factors that may explain why we are not making the right decisions when it comes to buying and selling stocks. Lets discuss two of them in this article.

The first factor – The fear of losing (or losing too much)

Consider the following; assume that you had to choose between these two alternatives:

– A sure gain of $240

– A 25% chance of gaining $1,000; 75% chance of gaining $0

According to statistics, you should have chosen the second option in which you will gain $250.

Which one did you choose?

Now, consider these two alternatives. Which one would you choose?

– A sure loss of $240

– A 25% chance of losing $1,000; 75% chance of losing $0

According to statistics, you should have chosen the first option – a sure loss of $240.

Which one did you choose?

Studies show that people feel the pain of loss twice as much as they derive pleasure from an equal gain. Consider your point of view - would you gain more pleasure or suffer more agony when you win $100 or lose $100? What if the figure were $10,000?

Most investors tend to sell an investment prematurely because they cannot bear to “suffer” any longer. How many times has this happened to you? Even worse, how many times did you witness the stock you just sold rise? An important thing to keep in mind is that the stock does not know you. It is not rising just to upset you. It is all in your head.

So, what can you do about this? How about familiarizing yourself with the value of a company before you purchase its stock? Or knowing the sell price even before you buy? Stay tuned for more on this topic in my next article.

The second factor – the need to be liked and our “urgency” society

As children, we are conditioned to believe that “you are who your friends are.” We develop personality traits similar to those of our friends and tend to act in ways that we believe will get people to like us and want to be around us. After all, don’t we all want to be popular? Who wants to be the kid with no one to play with on the playground?

As we get older, we are also conditioned to buy into society’s urgency mentality. How do you feel when the phone rings? Do you feel a pressing urge to act? The media contributes largely to this mentality by using words like “now,” “last chance,” and “don’t miss the bus.”

These two psychological factors are greatly affecting our investment abilities. When our friends share their investment successes, we want to be on their winning team! When we are told, “be sure not to miss the party,” we immediately feel the need to join the party (wouldn’t it be great at the Friday party to stand together with all your friends and tell stories about your stock market successes)? All the above cause us to believe that the only way to join the party is to do what your friends are doing (in this case buying/selling stocks).

As investors we feel more comfortable with the knowledge that our friends and peers own the same stock. It’s interesting to consider that we feel “better” knowing that if we lose money on a specific stock, we won’t be the only ones!

So, what can you do about this? Remember that deciding not to buy a stock is also a choice that we can act upon. Regarding the need to feel liked, take a moment to consider your end goal. Is your goal in investing to make friends or to create wealth? Stay tuned for more on how to overcome the need to be liked in my next article.

Amir Avitzur

President

Avitzur Asset Management, LLC

Amir.Avitzur@AvitzurInv.com


Rating: 3.2/5 (9 votes)

Comments

kfh227
Kfh227 premium member - 7 years ago
Some thoughts ...

I think it's from a movie ... "Hate is a more powerful emotion than love" Kinda hints at what was said in the article regarding emotion.

As for people buying hi/selling low. There was an interesting psychological study done. As it turns out, people only need to see three sample points to see a trend. What this translates into is people seeing the market going up (even in the short term) and they think they have to buy. Same for a downtrend. Better sell now before I loose more....

Anyways ... of the things mentioned in the article, I'm only guilty of the point relating to trends. If the Dow broke 13000, what is next? I know a pullback WILL happen. Bold statement, but let's be honest with ourselves.

I try to stay on the sidelines, but I'm human.

I do find comfort in Buffet's steak analogy though. I only buy things I view as a good deal. BAC and JNJ at current quote being two examples. If I were to buy and the stock drops, so what?
musto
Musto - 7 years ago


Amir,

you've raised some interesting questions about dealing with the psychological aspects of nvesting.

Investing is never just a cold calculation of intrinsic value. It's also dealing with your own doubts and uncertainties.

Some of your examples are too simplistic(but realistic) about keeping up with the Joneses etc. Even if you are emotianally able to deal with those, how do you effectively deal with higher level issues such as your own doubts about a purchase after you have bought a stock? How do you deal with yourself when your stock tanks 20%, or 50%? When should you bail out( I don't actually mean at what percentage level but at what discomfort level that it starts bothering you mentally)?

The answers are not that simple, and everyone's pain threshold is different.

In my case, when I purchase a stock, I try to set a really low point that I convince myself that I'd be able to withstand in case the stock tanks. I don't think too much about the upshot. I like to take care of my own emotions for the downfall, couldn't care much for the other way.

As for your idea about visualizing the potential positives about a stock, I think it's a good idea to put you in a happy mood, If you feel you need to be in that sort of a mood for whatever the reason..

musto.

buffetteer17
Buffetteer17 premium member - 7 years ago
When one of my picks tanks, I grit my teeth and review the fundamentals. A really strong conviction, based on knowledge, can override emotion. No matter how many people tell me that 2+2=3, I'm not going to believe it.

I thought eBay was a bargain last spring/summer around $32-$34. I bought. It dropped to $23. I sweated. I studied. I doubled my position. Now at $34 and my basis is only $29. Not great but not a bad profit. I looked hard, but I just could not find anything in the fundamentals that suggested the fair value was any less than mid-$40s. I'm still nervous though, and the last couple of times eBay peeked over $35, I sold little.
amir_avitzur
Amir_avitzur - 7 years ago
Kfh227 , Musto and Buffetteer17 - Thank you for your comments.

Musto,

You have raised very interesting points.

As per your question: “How do you deal with yourself when your stock tanks 20%, or 50%? When should you bail out (I don't actually mean at what percentage level but at what discomfort level that it starts bothering you mentally)?”, I agree that the answers are not as simple as my examples and I would expand more on that in my next article, however I would like to raise a question for you, Do you think that there is a possibility for a situation in which bailing out will be a “wrong” decision regardless of the drop of your stock price.

Personally I do not set a bail out price for any of my investments; I do regularly reevaluate the fundamentals and the questions that led to my decision (in writing). One of my past biggest learning was the basic learning of a stock price vs. a business value.

I found that for me the best way to overcome future mental discomfort is to start with asking the toughest questions prior to purchasing a stock. One of the best questions that I ask my self is a question that I believe Mr. Munger have raised which is “what will be the event that can bring the company to bankruptcy or to loosing its competitive advantage in a significant manner and what is the probability for this event to happen”, it also help to ask the questions that destroy your best idea on a regular basis (even better is to surround yourself with distinct smart people that help you with these type of questions, as human beings we have the tendency to be very “right” in our mind with our decisions).

One important factor is to do this process in writing, by doing so it enables you to refer back to it when the stock tank 20%, 50% or more and enable you to make more logical and less emotional decision.

I would love to hear your opinion.

Amir

musto
Musto - 7 years ago
Amir,

I'm totally on the same page with you about concentrating on the business value and not so much on the stock price.

In terms of bail-out time, I will come out of any investment if I start loosing my convictions in its business fundamentals. I may be up or down in the stock, but I'd come out in an instant when that happens. If a bad stock decision keeps me awake at night, I sell out right away. I have no problems admitting my own stupidity. I also believe, nothing is worth more than keeping my sanity.

I invested in BRK a while back and at some point the stock was down by half. That was in the heydays of the Nasdaq, when BRK was considered to be a boring old economy stock. The price drop didn't bother me at all, and eventually the stock as you may know recovered back. I had a blind faith in Mr. Buffett and I probably couldn't have stayed in it if it was a different person at the helm.

What I learned from that experience is not so much for sticking up with a tanked stock when your convictions are very strong, which I had no problems with. But rather, should have I been so fanatical about my opinions that blinded me from seeing BRK the stock was overvalued at the time even though the business had great fundamentals?

It's fine to say I'll stick with my convictions no matter what, but what if your convictions had flaws in them? Is it not healthy to leave a bit of room for doubt in your convictions?

At the end it will also depend on how good of an analyst you are. If your analytical conclusions were right most of the cases, you'd come out a winner. If I had holes in my analysis, eventually I will be a looser.

A successful investor will have to be smart, and have the right psychological temperament all at the same time.

I think investing is not as simple as how Mr. Buffett makes it sound like. Both his IQ and EQ have got to be genius plus levels. So no point in thinking we can all simulate him successfully just by reading his teachings.

Of course, as you all know it's also not too difficult to beat the market either, even for mere mortals like us.


musto.

billytickets
Billytickets - 7 years ago
Very enjoyable article. IN my recent article Bore yourself Rich, I mention that I only buy Large Caps for that reason.I averaged down on Altria and had considerable paper losses. Did anyone really believe with the government 7 trillion dollars in debt and the states collecting revenue on every pack smoking would become illegal or the legal system would let the company go bankrupt?
musto
Musto - 7 years ago
i enjoyed your article "Bore yourself Rich" too. I left a little note there about those stocks being price cyclical in the sense that, they go from being fairly valued to being richly valued. Nevertheless, always good invetments.

Btw, I always loved MO. It was my first stock purchase. In 1994(an old man i am). They were called philip morris back then. At the time I felt you needed nerves of steel to buy it because of constant legal issues. Their outlook is somewhat clearer now. Especially after they've partnered up with the states..

musto

traderatwork
Traderatwork - 2 years ago
"Consider the following; assume that you had to choose between these two alternatives:

– A sure gain of $240

– A 25% chance of gaining $1,000; 75% chance of gaining $0

According to statistics, you should have chosen the second option in which you will gain $250."

You are wrong, you should choose the second option if you are given say a lot of chances, say >100 or 1000 chances. If you have very limited chances, you should definitely choose the first choice.

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK
Email Hide