May 1

How to sell a stock

There are 3 stages in the evolution of a beginning investor.

First, you learn to buy.

Then you learn to sell.

Then you learn to earn.

Today, I want to talk about the hardest thing in investing.

Selling.

For many people who start investing, they hear about the conception of value by people like Warren Buffett. It hurts them to think that they would ever sell a business.

They say to themselves,

This is my PRECIOUS… no one takes my PRECIOUS away from me!

But sell you must, if you are to evolve to the next stage of investing – earning.

Why is it so hard for us to sell?

Firstly, you tell yourself that it’s a paper loss. After all, it’s just on paper, it’s an ‘unrealised’ loss. It’s not real!

You might be affected by the loss aversion bias. We would much rather hold onto a loss than to realise the loss.

One bird in the hand is worth more than 2 in the bush.

You know the saying. But you probably don’t know how it’s affecting you. For example, you might be loathe to let go of your losing position because your mind is telling you that the bird in the hand offers greater certainty than letting it go, even though its hurting you greatly!

Rolf Dobelli, in his book, The Art of Thinking Clearly,offers a brilliant suggestion.

If you want to convince someone about something, don’t focus on the advantages, instead highlight how it helps them dodge the disadvantages.

Tell yourself. It’s a paper loss now…

It’s going to be a permanent loss if you don’t do something about it.

Secondly, you may be guilty of the confirmation bias. when I first experienced my paper loss in Raffles Medical, with it going down more than 40%, I went searching for opinions on why I should continue holding the stock. I would go to esoteric forums, read on how everyone else there was saying that the stock was going to rise because of so and so factor.

Well, it didn’t.

How should you approach selling?

With all these cognitive biases, how should you approach selling?

First know how you are buying.

What are the tenets for you buying a stock?

Hagstrom offers 4.

Firstly, it’s the business. 3 questions you need to answer.

  1. Do you understand the business?
  2. Is the business in an industry of severe change?
  3. Do they have favourable long term prospects?

Secondly, it’s the financial tenets.

There are 3 factors you need to look at.

  • return on invested capital

Good business or investment decisions will produce quite satisfactory results with no aid of leverage.

Warren Buffett

  • margin of safety
  • cash earnings
    • free cash flow yield OR
    • owner earnings – company’s net income + deprecation and amortisation, less the amount of capital expenditures, and additional working capital that might be needed to operate the business

Thirdly, the market tenets.

Your role is to purchase a company if the price of the stock is below the intrinsic value of the company.

Lastly, it’s the management. Does the management of the company think like an owner?

Doing nothing is not an option.

When the stock falls 20 to 33%, what do you do?

Doing nothing is not an option.

Credit: Lee Freeman-Shor, The Art of Execution
Credit: Lee Freeman-Shor, The Art of Execution

As you can see from the above, the longer you allow the loss to slide, the harder it will be to recover your loss.

In investing, the ultimate goal is not to lose.

An investor needs to do very few things right as long as he or she avoids big mistakes.

Warren Buffett

Your job isn’t to try and win big.

It’s to avoid the big loss.

Doing this involves practical actions. When the stock falls 20 to 33%, you have to do something, rather than sitting there and twiddling your thumbs.

Telling yourself that it’s going to recover soon, or that this is a temporary blip, is not going to work.

After all, if the stock is so great, then why are you not gathering more of it after its fall?

It should be MORE attractive, not less attractive at the lowered price.

Let’s look at it this way.

Let’s say you’ve been wanting to buy a laptop for a long time.

Suddenly, there’s a 30% discount.

What do you do? Do you buy it, or do you say…

There must be something wrong. This is going to go up soon.

I will wait till it goes up before I buy it again.

Your mistake is not you.

You made a mistake…so?

You’re not the mistake. When you start investing, you’re bound to make mistakes.

The tendency is to let your self-worth be defined by the mistake you make, so much so that you find it hard to release yourself from realising the mistake, and moving on.

It’s hard to admit to yourself that you made a mistake.

Rather than framing it as a loss, frame it as a lesson.

Ask yourself these 6 questions.

These are adapted from Guy Winch’s book, Emotional First Aid:

  1. What should I do differently next time?
  2. What opportunities might my failure possibly present?
  3. In what ways might my failure make me stronger?
  4. What ways are my failures a success?
  5. How much more will success mean to you now that you’ve encountered failure?
  6. Can you identify ways you derived meaning and satisfaction as you pursued your goal?

There are better rates of return elsewhere.

I once bought a stock called Sing Holdings.

It’s been going nowhere for the past year.

Then I saw its history for the past 10 years… actually it had been going nowhere for the past 10 years. Sure, there were consistent dividends, but there wasn’t anything that would catalyse its growth.

That’s when I realised that I needed to reinvest the monies parked there elsewhere.

When you sell a stock, know why you’re selling it. It might be a good company, but you see some other company that might offer you a better rate of return.

How about when the price runs up too high?

Isn’t that a good thing?

Unless you have a better idea, keep it there.

Very often, we have an action bias in investing. We think that the more we do, the more we earn. That’s not necessarily the case. It might be that the more we do, the more we hurt.

Bruce Berkowitz once said,

Why not invest in your best idea rather than your 60th best idea?

If you’re tempted to do something, sell off some of it when you reach 30 to 40%. You might be capping the potential upside, but you allow yourself to sip your rewards slowly.

Don’t invest in too many ideas with limited upside potential.

Conclusion

My favourite Simple Face wash, not an ad though!

I need to wash my face. Above, you can see a picture of the face wash I use. I don’t own Unilever, so this is not an advertisement for them!

Still, they do great face wash products!

Because of how hard I was working to save money for my investing, I ended up cutting the face wash in half when I could no longer squeeze any out.

Below, you can see what it looked like.

It was a great budget tip… but not great in the long run.

Cutting it in half to scrape out the remaining dredges of face wash.

I realised that I was simply torturing myself for the mistakes I had made in investing. I told myself,

I have lost $3000 in the stock market… I can’t afford to lose more!

I need to save every penny!

I was self-flagellating.

I was living to invest, rather than investing to live. Investing is a process. It’s not the end goal. If you’re like Mr Scrooge (or like me), scrimping and saving to put aside pennies for the stock market… my guess is:

You’re not enjoying it.

Invest to live instead.

Investing can be fun, if you allow it to be.

Sure, investing is difficult. If you took nothing away, remember this.

When you sell, and you realise a mistake…realise that you’re not the mistake.

You made a mistake. And you’re courageous to admit that.

Don’t beat yourself up. Be kind to yourself.

Live to invest, don’t invest to live. You’re not your investments, and your investments are definitely not you.


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