Battling the market beast is no easy task. Being a successful active investor means consistently showing up every day to grind out positive results in a market that is very (very) good at frustrating its participants. Add to that the fact that we’re spinning our wheels 80% of the time in order to put ourselves in position to take advantage of the other 20% when the real progress is made, and it’s no wonder why so many wind up throwing up their hands in disgust.
However, one of the most common areas where active investors become most frustrated is when they’ve held on to a stock that had already broken down a while ago and are sitting on losses without any idea how to move forward. Recovering from a market setback is hard work (in fact, I dedicate a chapter to some ways active investors can do just that in my latest ebook), but if there’s one thing that I think is the most underappreciated (and most powerful) thing that would help traders avoid those holes, it’s learning how to use the sell button effectively.
The ability to quickly sell a stock is the most powerful tool that investors have at their disposal (particularly after almost every broker eliminated commissions back in late 2019), yet few are truly comfortable using it. For many, selling a stock for a loss is an admission of failure and oftentimes, the decision is driven by emotion rather than by a strategic assessment of the holding as part of a broader portfolio.
In reality, selling a stock (whether for a gain or loss) is part of the trading process itself and is an investor’s primary means of wresting control of their account from the market beast. It’s what allows you to manage your risk and move into a position to profit as new opportunities develop. Limiting losses by selling a stock that didn’t move the way you wanted it to is akin to the cost of insurance to limit your exposure when bad things happen.
One of the best ways that investors can overcome their bias against selling is by getting comfortable buying back a stock you’ve recently sold. I have found that when I sell and rebuy a stock that is bothering me, I feel empowered because it reinforces that feeling that, ultimately, I am in control of the situation and not the market.
The good news is that it’s not just individual investors who struggle with getting comfortable hitting the sell button. A paper published on SSRN in early 2019 found that portfolio managers could have improved their returns if they simply sold stocks in their portfolios at random, noting that, “while the investors display clear skill in buying, their selling decisions underperform substantially.”
The authors found that institutional investors struggle with the same emotional baggage just like everyone else, noting that they sell their big losers or their big gainers at a 50% higher rate than other stocks, simply because those are the stocks that produce the strongest emotional responses. The study concluded that the main reason for this is that managers tend to sell only when they are forced to due to market conditions. They do not have a systematic approach to selling but generally make the decisions only when they have no choice, and there is no longer a strategy at work.
Accordingly, here are some ways that active investors can get more comfortable with selling and turn it into a strategic tool rather an admission of failure:
- Create a trading plan for every single trade and make sure selling is part of that plan. Many investors spend a lot of time considering what and where they will buy a stock and often think of it as a singular event. Instead, think about building positions incrementally and managing the various pieces of that holding by selling pieces as the action develops. Ideally, a position will be small (what I think of as a tracker position) when conditions are weak, with the goal of increasing size as the action improves.
- Embrace the power of the sale. It’s easy for investors to come up with all sorts of reasons not to sell a stock that they’re holding for a loss, all the time forgetting that the decision can be reversed at any time. Instead, shift your mindset and remember that there’s literally no reason to hold something that is dragging down your portfolio. And, if the stock suddenly reverses and becomes attractive, the cost of missing that initial bounce was simply an insurance premium you paid to control your risk.
- Selling down positions at random can be an effective strategy. Doing so is a great way to change your perspective on the market and recalibrate your emotions. I’ve often found that simply clearing the decks will help shift my mindset, as I’m no longer wrestling with stocks that just keep struggling. Starting with a clean slate can often serve as the catalyst to regaining your market mojo.
Selling is the most powerful tool you have at your disposal. Do it and do it often. It will improve your results tremendously.
