Buying a stock is the easiest part of investing. It takes almost no effort at all, especially if you have a streamlined process in place, a sort of quant strategy to highlight what you should be buying and selling.
Even if you do not have such a process in place, buying a stock is easy without any research beforehand, all you need to do is click "buy."
It is in the selling the problems start to mount. There is enough research proving most investors are terrible at picking stocks. Using this logic, let's assume you have a 50-50 chance of picking a winner. If you win, great. If you do not, that is bad.
In both cases, you still have to know when the best time to sell is.
When to sell
Now, I am not advocating just throwing money at the market in the hopes some of it works. The above is just a rough example of how easy it is to buy a stock compared to selling. If you have a process to follow before buying, then the ritual you track will make the whole process more time consuming, but it will still be easier buying than selling.
Psychology plays a huge part in an investor’s selling process. Loss avoidance coupled with confirmation bias can be a toxic combination. Research has shown investors feel more pain (psychologically speaking) taking a loss than a profit, even if the monetary value involved is similar.
Even on the winning side, it is difficult to gauge when to sell. The great saying "let your winners run and cut your losers" is hardly helpful in this matter. If you had bought Amazon.com Inc. (AMZN, Financial), Apple Inc. (AAPL, Financial) or Alphabet Inc. (GOOG, Financial) at their initial public offerings and sold after a gain of 100%, you would have done well, but you would also have missed out on decades of future gains. This would not have been a physical loss, but the fear of missing out may push you to take on more risk and chase profits, seeking to vindicate your decision to sell.
What I am trying to say is selling is hard, no matter how much you have researched the opportunity in the first place.
Having a process in place
So what is the solution? Danny Kahneman’s "Thinking, Fast and Slow" contains a solution to this problem. Kahneman highlights the idea of system one and system two thinking. System one thinking is instinctive, while two thinking requires more processing.Â
Having a process or checklist to decide when to sell is critical in making sure you sell when the situation changes.
I believe three red flags indicate it is time to sell:
Management lies. As an ordinary shareholder, you are entirely dependent on management to make the right decisions. You have no say in the day-to-day running of the business. Therefore, it is imperative you trust the management. There is nothing that breaks down this relationship of trust more than lying. If management lies to investors, enriches itself at the expense of investors or fails to achieve what it set out to do, this is reason enough to sell. If you cannot trust management to look after the company as an investor, why would you own the stock? You would not co-own a restaurant with someone you knew was lying to you, so why would you do the same with a public company?
The investment case has changed. This criterion is a little hard to quantify, but ultimately it rests on your ability to put together a solid investment case before buying. If the investment thesis changes, and you cannot understand why, or what the company is trying to achieve is changing, it is time to get out.
You have found something better. Selling because you have discovered something better is a crucial part of investing. Sometimes an investment does not work out, which is just part of the process. Finding something better and moving on is also part of the process. Sometimes the new idea will offer more opportunity than the old, and using this discipline is a great way to clean up your portfolio and trade out of positions that have not lived up to expectations.
These are some guidelines on when it is best to sell a position.
On the other hand, you may be faced with a situation where you own a stock that is up 100% and you want to take profits, but do not know if you should. Here is some advice from legendary investor Philip Carret:
“It is very simple; buy good companies and sit on them. There are good well-managed companies, which are a relative handful. There are companies that have moderately good management, which at least are not going bankrupt but probably are not going to give their stockholders glowing returns. There are companies which are over-leveraged — they owe a lot of money and are skating along on thin ice; when things get tough they are going to go bankrupt. So the job of an investment manager is to pick the good [companies] and sit on [their stock for many years].
One of the great faults of investment analysts is to try to put limits on what they recommend. They say, for example, 'Here’s a stock selling at $12 [a share]. Sell at $18 a share.' That’s nonsense. If that’s all you expect out of it, leave it alone. If you buy it at $12 and you think it might double, one should feel comfortable in buying it. Probably the greatest performer in recent history is Berkshire Hathaway. [Berkshire Hathaway Inc., based in Omaha, Neb.] I bought the stock about 10 years ago at $400. Imagine how I’d feel if I sold it at $800. [It was recently selling at more than $24,000.] Why sell anything unless something goes wrong?"
Disclosure: The author owns no stocks mentioned.
