Having the discipline to sell stock when the conditions are right is really one of the hardest things. (Image: 123RF)
The old principle of buying low and selling high is often used as a sarcastic response to those seeking investment advice in stocks. Of course, if we could do all that, we would no longer need the stock market.
Having the discipline to sell stock when the conditions are right is really one of the hardest things about investing. But why the difficulty?
Our behavior is playing against us
We are generally prone to all kinds of bias. Often this means that we are making bad financial decisions. As the saying goes, “to err is human, to forgive is divine”. Unfortunately, mistakes with investments can not be forgiven so easily if you want to achieve your financial goals. Self-reflection can lead to recognizing certain biases and avoiding them by comparing objective facts, which is often a worthwhile exercise before deciding on a transaction.
For example, as an investor in stocks, you will inevitably encounter a stock market crash. A common bias called “loss aversion” can cause an investor to sell their positions during a crash and lock in their losses, while losing money on recovery. Another common bias is the “confirmation bias,” where an investor seeks information that can confirm their views or opinions and give it more weight than the information that contradicts it. This, of course, can cause an investor to hold a stock too long.
In other words, biases are not friends of investors. The first step, identifying them, is important for a disciplined investor. After that, it is important to recognize how a person invests.
There are different investment strategies.
There are a whole range of strategies for investing in stocks. Understanding the investment style that naturally suits you will help you define a pattern or plan of action for evaluating buying and selling opportunities. Here are three main styles, and they are not the only ones:
1. Value Investing: Just as Morningstar assigns ratings to stocks, value investors try to assign “fair value” to it, usually based on a projection of its future cash flows, then use a discounted cash flow model to estimate how much should be worth now. For value investors, the best time to sell is when the price of a stock has reached or is close to its fair value estimate.
And (no coincidence) that’s exactly the Morningstar Star Rating for stocks. An undervalued stock receives 5 stars, a fair value company 3 stars, and an overvalued company 1 star.
Value investors can also use valuation ratios such as price/profit, price/sell, etc. as measures to determine whether a stock is trading with a reasonable number of other stocks in the index, particular sector or industry. In this case, investors may consider selling a stock if much of it is higher than comparable companies or a larger universe such as an index.
2. Growth-oriented investing: Growth-oriented investors are often looking for opportunities with the potential for rapid growth for a company. In contrast to value investing, growth investing does not care about a company’s current value, and prefers to focus on the company’s ability to generate revenue in the future.
Overall, the growth style has become a big favorite over the past decade due to huge advances in the technology sector, where growth stocks often emerge. Here, investors are likely to view a company’s historical earnings growth, the sentiment expressed by analyst estimates, and historical profitability as metrics to assess whether the company’s current growth continues to meet expectations. . When core growth slows, as a missing earnings report or a declining earnings trend might indicate, growth-focused investors may consider disposing of the growth stock.
3. Momentum investing and technical analysis: Like church and state, momentum investing is in conflict with core investment, which includes growth and value. Here, investors tend to follow the trends that dominate prices, an approach based on the theory that the market is efficient, and all the information is immediately reflected in the price of a share. Momentum investors typically rely on market signals that indicate that the price of a stock is no longer following its previous trend. For example, when the 50-day moving average of a stock’s price falls below its 200-day average, momentum-focused investors may interpret it as a reversal of a trend, because the prices are lower than they were in the more distant past. .
It should be noted that momentum investing is not for the faint of heart, requires constant monitoring and usually active trading within a portfolio.
Develop a strategy
Regardless of the style (or combination of styles) used, the key here is to give yourself a way to invest with a strategy in mind. It is often useful to determine if the conditions that led to the purchase of a stock in the past are still valid today. If not, you have to sell. Of course, this is easier said than done, but persistence in this way over time will definitely give better results than focusing on the thrills. Using benchmarks written in a spreadsheet, financial software or even using pen and paper is a useful tool to ensure that objective comparisons are made regularly.
Life tends to be disruptive
Of course, the other reason to liquidate an investment is the change in living conditions. For example, if you need this money to buy a house or to start your retirement, you need to sell. It’s important to think about future changes in your life circumstances, whether in the near future or a few years from now, when deciding which stocks to buy.
In nature, equities carry greater growth potential and risk than bonds. Aligning your asset allocation (combination of stocks and bonds) with your risk profile and the time you need to invest is very important if you want to avoid liquidating in a bankrupt position, to discover subsequently that you may not achieve your financial goals.