I have written about the folly of cutloss for cutloss sake and how it will deliver you to ruin. If you think about it, cutting losses just because the price went down is just the same way as saying “buy high, sell low”. Its not very sustainable and will ultimately bankrupt you after a string of bad trades.
That’s also the reason why there are so many failed traders. They think that cutting losses will give them profits. How would it? If you keep throwing away your money by selling low? Its just common sense isn’t it? How would you become profitable if you keep giving away your money through cutloss? Aren’t you oversimplifying risk management by indiscriminately selling your stock when it goes against you?
I know you might be asking, “If you don’t advice people to cutloss, are we not allowed to sell?” Of course you are allowed to sell. But only in a few, very specific circumstances. As an investor, your mode of operation is different from the traders who thinks minimizing risk is selling when prices are falling. That’s actually where you buy and not sell. But to arrive at the right decision when you sell a stock, you have to think carefully.
Let me tell you what I think are the scenarios where you are allowed to sell your stock.
Reasons When to Sell a Stock
1. You were wrong
The first reason why you might want to sell a stock is if you realize that you are wrong. This may be a wrong investment thesis or your fundamental analysis is wrong because of wrong information.
Of course, being wrong is not only when the stock went down. It is also when the stock went up. Prices do not determine if you are right or wrong. Just like how Graham told us that we are neither right nor wrong because the market went up or down. We are right because our reasoning is right.
Once you realize that you made a wrong investment, you should sell as quickly as possible. Even if the stock went up (or down). Price must not dictate what you do as an investor. You make action because your reasoning is right. The only basis if you’re right or wrong is the intrinsic value of your investment.
2. You Need the Money
Money is meant to be used. There’s not much use for money if you don’t use it. So people who accidentally needs money now for emergency may sell some of their stocks to pay for these emergencies.
It is important that if you’re compounding money for retirement that you don’t withdraw this money and let it compound. But hard times sometimes calls upon us to make decisions. In these times, like the pandemic, it is understandable to sell some stocks to pay for health or living expenses. In that scenario, it is a valid reason to sell.
If you’re gonna need the money in less than a year, you shouldn’t be investing the money in stocks anyway. So if you do sell your stocks to pay for expenses, make sure this is your last resort.
3. You Found a Better Investment
Warren Buffett during the 1975 crash told in his annual report that he was selling companies with P/E of 4 to buy companies with P/E of 2. What this means is that, its ok to sell your stocks, even if they haven’t go up in price yet, in order to buy stocks that are much better investments.
To take it even further, if you found a better investment in real estate than in stocks, its only rational for an investor to move some of his money to this better investment, no matter what kind of vehicle it may be. Keeping in mind that you know something about this investment vehicle to competently judge so as better investment. In this situation, selling is a rational decision.
Personally, I find this hard to do because when I buy a stock, I tend to not make any decision. I am partial to “doing nothing” than moving money around and constantly finding better investments.
I also made a mistake of selling a stock because I think that the other stock is a better investment. I once sold a stock and used the money to invest in another stock that went up 30%. It was a bad decision because the one I sold went up 5x. It’s a lot harder than you think, so I am partial to not selling.
4. Things Change
Investing is an ongoing process, so is business. The businesses that we buy may be good today and are bad years from now. So its important to monitor your stocks and be updated of what is happening in the businesses you own. So when time comes that you see that your businesses may not be as good as they were before, you are ready to sell and let go. You can then move on to other investments.
Selling a stock because you know that things have change and you know confidently that your stock might not be a good investment now than before, is a rational thing to do. We don’t want to get married to a stock but we do want to stay for as long as the business is within our expectations and within our reason for buying. But when it’s time to move on, just treat it as business.
The Benefits of Not Selling
Think carefully before you sell. Selling is harder than buying a stock. And there are a lot of benefits if you do not sell your stock.
- No fees
- Deferred taxes
- Compounding effect
You might have noticed that I didn’t include selling to take profits. That is another habit that is bad for the investor. Profiting from your investments would be a normal effect of selling because you found a better investment or because things changed. But it should never be a reason for selling. No sane investor would sell a stock because it’s already profitable. You are leaving money on the table by interrupting the compounding of your investments. And besides, if you have a great business and bought it at a great price, why sell?