Andrew Page |
Knowing when to buy is certainly a tough decision, but I’d argue that knowing when to sell is even more difficult. In fact that’s the case no matter what direction your shares go.
Let’s consider the three possibilities, starting with the worst case scenario. Say you were unfortunate enough to enter into a position only to see it lose value. If you exit the position you crystalise the loss, but prevent any further downside risk. If you hold on, you’re still exposed to any further loss, but you also have the chance of seeing your position improve and move into profit.
In some ways, it’s even harder when you enter a trade that immediately moves into profit. Of course that’s exactly what you want to see, but at what point do you close the position and lock in your profit? How many times have you sold out only to see the price continue to climb to ever greater heights? Worse still, what if you failed to sell out at the right time, and watched in horror as a profitable trade turns south and ends up in the red?
Finally, there’s the possibility you could find yourself in the frustrating situation where you buy into a stock only to watch it move sideways. In essence this is like a loss because of transaction costs and opportunity cost.
The more experienced traders will not be troubled by these dilemmas because they understand a few simple truths. If you are new to trading, you would do well to embrace these, which I will outline below.
- Could’ve, would’ve, should’ve
Understand that the perfect trade is an extremely rare thing. It’s virtually impossible to consistently buy into a stock at the absolute low and then sell at the exact top of the market. So no matter what trade you take, you will, with the benefit of hindsight, be able to say what you could have done better. But that’s a waste of time. Be happy that you have achieved a positive result (or accept that you made a poor call) and move on.
- Expect to lose
No matter how good you are as a trader, you will inevitably take a losing trade from time to time. That’s just a fact of trading. The best traders in the world will regularly experience a loss, it’s just that they tend to cut these quickly and understand that success is never defined in terms of one trade. It’s the sum of all trades over a period that counts.
- If you fail to plan, you plan to fail
This is perhaps the most important point. Successful traders aren’t faced with having to make difficult sell decisions, because they have planned in advance under what circumstances they will exit a trade. Prior to entering a position, they will have a plan which stipulates what return they are targeting, and at what level they will take a loss. These will often be based on either technical signals or percentage changes, but the important thing is that they are set in stone and are acted on in an objective and unemotional way. The trader that has a clear exit strategy which accounts for both the best and worst case scenarios is never taken by surprise.
- Consistency is king
It’s better to notch up many small victories rather than always looking for the one big win. Sure it’s nice when you get one, but you can’t rely on them as your bread and butter. If you can generate an average return of 10% for your trades, you are doing extremely well. It may not seem like a lot for each individual trade, but if you add them up and annualize the returns you will be surprised. For example, if you manage to increase your capital by 10% every month, with compounding you will generate an annual return of approximately 185%!! Indeed even an average return of 2% per month results in an annual return of 24%, which is better than what most funds achieve consistently.
- Returns are relative
One common mistake beginners tend to make is to think in dollar terms, rather than percentage terms. Ask yourself who is the more successful trader – the one who makes $10,000 a month or $1000 a month? The answer; it depends on what capital they are working with! If the first trader is working with a million dollar trading account, and the second trader has only $10,000, I would argue that the latter is the better trader. After all, they have generated a return of 10% in a month, whereas the other trader has generated only 1%. This is very obvious when you think of it, yet behavioural finance studies consistently show that the size of the position directly influences our judgement. The point is that you shouldn’t concentrate on your dollar returns when trying to decide when to sell – instead measure your success in percentage terms.
- Is your capital a productive worker?
Understand that your capital should always be working as hard as possible for you. The question of whether or not to sell is really a question as to whether your capital would be better placed elsewhere. If there is nothing wrong with your current holding, and the future remains bright, it may well not make sense to sell even if you are currently riding a large profit. The important thing here is to not over-trade; if you are considering switching your funds into another position you need to be very confident it offers the potential for significantly better returns. If the new position only confers a small advantage, transaction and tax charges may not justify the switch.
So in conclusion, if you are having trouble deciding when to sell, it’s probably because you have ignored the above points. If you are realistic in your expectations and trade with a clear plan, you will be much more likely to find success in the markets.
Make the markets work for you!
Andrew Page
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