Your stock is falling – should you sell? Indecision can be costly in a market where stocks regularly lose ten percent in a day.
One thing is certain: you don’t want to sell stock while it’s rising. But when it comes to falling stock, selling is just one of several options: you might hold because you think that the worst of the falls may be over, or that there may be a brief upturn, offering you a better exit price.
Of course, the rule of thumb offered by professional traders is to cut your losses short. Take the following three (fairly common) rules about when to sell: sell if the share price drops by a certain percentage, say, 30 percent; sell if the company issues a profits warning; sell if a major brokerage issues a company downgrade. Such rules don’t guarantee trading success, yet despite such sound advice, traders are still plagued by indecision.
This indecision can hardly be blamed on lack of information either - not when the internet offers up-to-date, accessible data on share price drops, profits warnings and even broker downgrades – see TipRanks for instance.
No, the problem isn’t lack of advice, lack of information, or even the perceived difficulty of selling shares online. It’s the mindset of the traders’ themselves: the fear of taking the plunge and committing themselves to cutting their losses.
If you find yourself in that position, focus your mind on the following five arguments:
Selling a loss-making stock is a saving. Suppose you bought £15,000 of a stock then sold it for £13,000. That could save you from further losses of, say, £3000 – a saving that could then be compounded. For instance, imagine that two net traders both own £15,000 of ABC stock: the first one takes a £2000 loss; the second trader waits, but eventually takes a £5000 loss. Even if the rest of the year brings them both a 40 percent return on the cash they have after the ABC trades, the first trader’s portfolio will still outperform the second trader’s by 30 percent.
Selling unties capital. Let’s say you hold fifteen stocks in your portfolio. Is the loss-making stock you’ve had trouble selling really one of the best fifteen stocks for a return on your capital? Too many net traders focus on their tally of winning trades, not the profits across all their investments. They hold onto losing stocks to avoid having a losing trade – “It’s not a loss until I sell the stock; it’s only a loss on paper.” Wrong. The market does not care which stocks you lost money on or made money on, and neither should you. Untie your capital and invest it in stock that offers the best return for the risk you are willing to take.
Selling at a loss can avoid over-compensation. Net traders who take a large loss on a trade often follow it with a bigger, riskier trade to try to recoup that loss. You can avoid this pitfall by taking a smaller loss earlier.
Selling improves performance. A net trader will expend more mental energy on a losing position than a profitable one (you get stress from sitting on a £10,000 loss, not a £10,000 gain!). It is better to sell, take a loss and spend your time looking for better opportunities, than to keep fretting about a stock that drops little by little. It’s the trading equivalent of the death of a thousand cuts: each day brings another tiny loss, not enough to trigger a sale, but enough to gradually bleed your performance dry.
Selling according to your own trading rules is the real measure of success. Leading traders don’t focus on the loss they may be taking when closing a position; their concern is whether they followed their trading system. Find yourself a set of trading rules, and test them to see if they will make you money. If they do, then follow those rules and the money will take care of itself.
Ultimately, the tough part is committing yourself to that first, loss-making sale. No amount of trading advice can steel you for that moment. But when you do, you may find yourself echoing the words of Brian Winterflood, managing director of Winterflood Securities and one of the highest paid city brokers: “The first cut is usually the best cut.”