Stock Selling Decision and the Bias of Owning Stocks
Are You Confused when You Are Met With a Stock Selling Decision?
Stock Selling Decision Dilemma
If you ask most investor groups, they will tell you that it’s just as difficult to make a decision to sell a stock than to buy one.
Why is that?
Behavioral Challenges of Stock Selling Decisions
#1. Loss Aversion Affecting the Stock Selling Decision
Did you know that professional golfers do significantly better when putting to save par than when putting to make birdie?
Investors focus on the investment that’s losing money. When you look at your portfolio, do you sort it so the losers show up first or the winners?
This behavior is called loss aversion.
It’s common to sell winning stocks to “take some profits”. On the flip side, it’s difficult to accept defeat when it comes to loser stocks.
Philip Fisher wrote the following in his book Common Stocks and Uncommon Profits.
“More money has probably been lost by investors holding a stock they really did not want until they could ‘at least come out even’ than from any other single reason.”
– Philip Fisher
Losing money is painful. It’s 2x painful than winning.
Further reading: Loss Aversion is the Biggest Trap for Investors
#2. Representative Bias
Losses hurt.
Losing sucks.
To offset this painful experience and feeling, it’s common to be optimistic about a stock before buying it. The problem is that optimism can get you into trouble.
The next Microsoft, the next Apple and the next Google is what most investors look for. News and information about such optimistic companies is all over the place and makes the information easily accessible and available.
When it comes to explaining problems and teaching, using similarities and analogies work wonders. But not for investing.
When headlines scream things like “Facebook is the new Google”, it’s called representative bias. A bias where you assume that something similar will have similar outcomes.
And so, investors hold onto a stock hoping for the 10,000% lotto jackpot instead of knowing when to sell.
Further reading: Beware the Representativeness Bias
#3. Availability Bias and the Illusion of Knowledge
The internet has polluted the availability of information.
Everyone is a market expert.
There is just too much information that even the bad info sounds correct. Because it is so easy to accumulate and hoard information, investors can be swayed to make decisions on what information is available and not on what is important.
All this information also causes the illusion of knowledge.
More information means more knowledge and therefore leads to better decisions. Right?
Nope.
More information can make you feel confident and not just financially invested, but psychologically invested which makes the whole stock selling decision harder.
Further reading: Behavioral Finance: Key Concepts – Overreaction and Availability Bias
#3. Ownership Creates Issues More than You Think
Think back to when you bought your car. Notice how all of a sudden there are so many people with the same car on the road?
Your car suddenly becomes “the” recommendation when anyone asks your opinion on what car to buy. If somebody says otherwise, you look for specific information to discount any conflicting information.
Happens all the time in life.
Happens all the time in investing.
- Endowment effect: you place a higher value on something simply because you own it
- Confirmation bias: looking for information to confirm your thoughts and views
These effects cause investors to ignore information that are reasons to sell.
Further reading: The Endowment Effect, Loss Aversion, and Status Quo Bias
#4. Status Quo Bias
This is where you prefer for things to stay the way it is.
How does this relate to investing?
Most times, it’s easier to just “hold” your position instead of revisiting the stock to see whether you should buy more or sell it.
Further reading: How to beat our status quo bias
#5. Anchoring on Purchase Price
The moment a stock is purchased, the buy price determines the gains and losses.
This brings the disposition effect into play.
It’s where investors sell winners early and hold onto losers longer than necessary.
Since losing is painful, investors are more willing to “lock in gains” or “take some off the table” for fear of a sudden price drop or temporary setback.
These decisions are costly.
Jae brought this up recently on the OSV facebook page with some great discussion.
Jae Sells his Stocks too Early. Tisk Tisk. =)
Further reading: Stock selling decision and some tips
When Faced With a Stock Selling Decision Here are the Dos and Don’ts You Need to Follow
Here is a list of tips I have adapted from a Schwab magazine titled On Investing.
- Develop a strategy that clearly identifies the characteristics of stocks you will purchase. You can use the OSV Stock Analyzer. This awesome valuation tool will help you make objective and consistent decisions.
- Avoid “story stocks” and do not listen to stock tips from unproven sources. Check out the Warren Buffett Quotes. I know you get sick of hearing it, but remember to do your own studies.
- Keep a journal of the reasons why you like to own a stock and what will make you sell. When I’m writing things down in my notebook, my brain seems to remember better and analyze faster. When you write down your answers, you may realize that you really don’t have a reason to buy it in the first place.
- Don’t check your portfolio so often. Easy to say but difficult to do. So much information everywhere. Even if you don’t want to check, you’ll be blasted with what the market is doing everywhere you go. Worth a try though.
- Create a sell rule and stick to it. Regularly evaluate each stock against your predefined sell rule. If it violates your rule, sell it regardless of current or purchase price.
- Don’t sell based on price. “Price is what you pay, value is what you get”. Use price to your advantage, not as an indicator of the company fundamentals.
Further reading: More stock selling decision tips from OSV
