Buying and selling stocks should be two sides of the same investment coin: You buy when there is potential for gain and you sell when that potential no longer exists. If you really know why you buy something, you should know when it’s time to sell.
But it’s not so simple, is it? Selling carries a higher emotional toll and is simply a harder discipline. Just take a look at the CFA Institute’s survey of investment professionals on what investment activity is most emotionally difficult:
Of the 711 investors who responded, 43% said that selling was most difficult, while only 3% said buying was.
Buying is a time of optimism and excitement. Selling is a time of reassessment that can invoke fear, regret, and other unpleasant feelings that we generally try to avoid. If things have gone swimmingly well and we consider selling to lock in profit, we fear missing out on future gains. If things have gone badly, we must admit we were wrong.
The traditional explanation on why selling is hard involves the endowment effect. That’s the idea that we value the things we own much more than things we never had – simply because we own them. As crazy as that sounds, we see the endowment effect all the time when people try to sell their own homes or other possessions at inflated values. In the classic study on the endowment effect, Kahneman, Knetsch, and Thaler gave out mugs for free to some randomly selected students, but not to others. Those who owned the mugs valued them at an average of $7, while those who didn’t own them valued them at $3 – even though the mug owners had done nothing to earn ownership.
If that’s what we do with coffee mugs, you can see how clouded our thinking gets on the stocks we own.
There’s a host of recommendations for bringing more discipline to your selling. When you buy a stock, you can write down both your reasons for buying it and the conditions under which you would sell it in a journal. That way, you won’t invent new reasons for owning a stock when things go terribly wrong. When you’re regularly assessing your holdings, you can ask, “If I didn’t own this stock, would I buy it today?” You can set numerical price targets – or other quantitative conditions. Mechanical guidelines can make selling less emotionally fraught -- though no guidelines can fit every situation.
Above all, however, perhaps it’s best to be ever-aware that as human beings, we always seek to avoid loss. The pain of loss is much greater than the pleasure of gain, and we can do some crazy things to avoid regret. Berkeley professor Terry Odean once wrote, “. . . when people buy stocks or any investments, they really focus on the future. When they sell, I think a lot of investors focus on the past.” And that is hard indeed.