Investing psychology is a fascinating topic. In a portfolio management class in the past, we learned that psychology is one of the biggest reasons for increased investment losses. Investors are often apprehensive when it comes to selling a stock for a loss, as it might come back. They are also afraid to sell when the stock is up, as they do not want to lose more upside potential.
The key to a good fundamental analysis strategy is to look at the stock for what it is today, make a decision, and stick with it.
If you have a stock that you bought for $10 and is now at $15 per share, the $10 price is 100% irrelevant other than for tax reasons. If you bought it for $10 and now it is at $5 per share, the same holds true. The past is the past. Like with a poker hand, you may have to fold and take a loss, stay where you are, or increase your bet. You do this based on the intrinsic value of the stock, not on the past value of the stock.
I have recent examples of this from my own portfolio, both good and bad, that we can learn from.
Varian Medical Systems (VAR) – I bought this stock because I thought it was going to go up. It did. It went up a lot. One day, however, I realized that it had hit its peak. Many investors would have held the stock and hoped it would have continued to rise. I realized that it had fulfilled its potential for my investment goals, and I sold the stock. It went up a little more, but then went down. I made the right choice.
World Wrestling Entertainment (WWE) – I bought WWE after doing an in depth analysis. I found that the stock was grossly undervalued. I bought it and watched it rise over 30%. I didn’t do the right thing, and I let my psychology take over. I am a fan of the WWE, so I held it even when earnings turned around.
After it went down and I was sitting with a nice 10% loss, I kept telling myself that it would come back. In the words of the internet: epic fail. I waited until another bad earning announcement came out and sold for a loss twice as big. It was not coming back and I had to get out, which was the right decision. It is the only stock I ever sold for a loss, and it was because of psychology taking precedence over the numbers.
The key is to stick with what works. Use a strong fundamental analysis and buy or sell accordingly. Don’t worry about the past, only focus on the future. If the stock is not going up, it should not be in your portfolio.
You might be a prime candidate for a trailing stop strategy. I agree, though, selling both winners and losers is difficult. For my long-term portfolio I like to buy companies I never envision selling.
When to sell is, after all, way more important than when to buy.
I like using trailing stops sometimes. It keeps you from doing something stupid like sell when it is going up but protects you on the way down.
Awesome article. Balanced with both a good trade and a bad trade. The WWE trade was tricky as you loved the company and product. Like you said, this affected your investing discipline. Funny, same for me, when emotions get involved, I end up losing. Have to turn off emotions when dealing with the irrational stock market. 🙂
Emotions are bad at work and the stock market. Something I (try to) live by.
Good thought. I usually do that pretty quickly on my Google Finance portfolio.