Feeling good about selling a profitable stock may be very pleasurable, but this should not be the motivation behind your financial investment strategy
Be like a methodical chess player, and think ahead.
When you go shopping, do you sometimes buy something just because you like feeling that you got a good deal, even if you don’t necessarily need the product?
This is similar to the feeling an investor may have when he sells a stock at a profit, even if that transaction isn’t necessarily the best move in terms of proper portfolio management. If he sells the profitable stock, he can tell himself and his friends, “I made a killing on Stock A!” It certainly makes him feel good and makes excellent cocktail-party conversation. Behavioral finance experts refer to type of trading as the “disposition effect.” People dispose of one stock even if there would be a better stock to sell from their account.Credit: Image: ntwowe / FreeDigitalPhotos.net
Investors like the feeling that they made a profit. But though the joy of selling at a profit might have some emotional significance, actualizing a profit may not always be the wisest financial decision; it might be better to sell a stock that is losing money. In a study of tens of thousands of self-directed brokerage accounts, Professor Terrance Odean of the University of California found that, on average, one year after people sold a winning stock, it had outperformed the stock that they kept (the loser) by about 3.5%. If they had made the statistically rational, albeit emotionally more difficult, decision to hold onto the winner so that it could keep going up, they would have generally pocketed more money. (Listen to Doug Goldstein’s interview with Professor Odean at www.GoldsteinonGelt.com You can also read a transcript and watch a video of my interview with Professor Odean.)
Also – remember that past performance is no guarantee of future returns.
Don’t Make Poor Moves
Chess players, too, make poor moves based on the disposition effect. Perhaps they have a well-placed knight controlling the center of the board, ready to pounce on several of the opponent’s pieces. Yet at the same time, the opponent’s bishop remains impotent as it sits trapped in a corner, locked in by some of its own pawns. In this situation, the more amateur chess player might conclude that he could swap his knight (worth only three points) for his opponent’s bishop (worth 3.5 points) and come out half a point ahead. But what is he really doing? He is making a cosmetic move, thinking he’s profiting half a point, yet he is setting himself back in terms of his long-term goals of growth.
Let’s try to be winners in our own personal investment game, making more calculated decisions, rather than trading simply to feel the temporary buzz of a fleeting “win.”
Disclaimer: This article is for educational purposes and is not a substitute for investment advice that takes into account each individual’s special position and needs. Past performance is no guarantee of future returns.