Random thought on selling stocks

Circle of Competence don’t means that you have to know everything about a company and you will do fine for me – you also have to know yourself – how will you react under pressure, under seductions? As Ben Graham have written, you can find the biggest danger for your portfolio in the mirror.

One of the hardest tasks in investing is finding out how to act right when selling a stock. With this article I will look at the difficulties and forces that come into play when I’m thinking of how to sell a stock. I hope this will make me better in that area.

 

Beeing aware of some psychological pitfalls

Commitments

If people commit, orally or in writing, to an idea or goal, they are more likely to honor that commitment because of establishing that idea or goal as being congruent with their self-image. Robert Cialdini on Wikipedia

Seeing oneself as a value-investor and buying a stock is a perfect commitment according to Cialdini. Buying a stock is linked with:

  • creating a self-image (I am a value investor who is practising buy-and-hold)
  • effort (you research, you push the buy-button, you pay the money)
  • a decision
  • (maybe) making your decision public (blog, friends, your broker)

Once a commitment has been made, the psychological program that is called “I made that decision-I will stand to it” starts working. You can imagine easily how this affects the selling of an already owned stock.

Confirmation bias

The Confirmation bias is one of the biggest thinking errors. It’s the psychological program that filters new information’s and compares them with our one viewpoints and ideologies. We tend to search information’s that reinforce our own believes.

Confirmation bias is the tendency to search for, interpret, favor, and recall information in a way that confirms one’s preexisting beliefs or hypotheses, while giving disproportionately less consideration to alternative possibilities. Confirmation bias (Wikipedia)

So once you decided that a company is a good company and a good investment, your brain will search for confirmations of this thesis everywhere.

With intelligent algorithms that “scan” your interests and present you matching content – content that you probably will find appealing – this bias got stronger in the past.

 Loss-Aversion Bias

… because you don’t want to admit that the loss has gone from a computer screen to real money, you hold on in hopes that you will, one day, make it back to even.

It’s hard to admit that one has made a mistake. Admitting an error is humiliating, at least for some people. People often hold on to mistakes just for the sake of not admitting them.

“The most important thing to do if you find yourself in a hole is to stop digging.” – Warren Buffett

Endowment Bias

Similar to loss aversion bias, this is the Idea that what we do own is more valuable to us than what we don’t own. There is a psychological experiment in wich passersby should value a Mug. When them were said in prior they can keep the Mug (“This is your Mug, you own it now”) they valued the Mug higher.
They found that the amount participants required as compensation for the mug once their ownership of the mug had been established (“willingness to accept”) was approximately twice as high as the amount they were willing to pay to acquire the mug (“willingness to pay”).
Humans value something they already own higher compared to something similar they don’t own. You can imagine easily how this affects selling an already owned stock.

Anchoring

Probably one of the best known and most made mistakes in investing.
An anchor can be any number. It can be the price you bought for, a round figure you are planing to sell something for. You can even be affected by random number which totally are of topic. “Once an anchor is set, other judgments are made by adjusting away from that anchor”
From Wikipedia (link):

Difficulty of avoiding

Various studies have shown that anchoring is very difficult to avoid. For example, in one study students were given anchors that were obviously wrong. They were asked whether Mahatma Gandhi died before or after age 9, or before or after age 140. Clearly neither of these anchors can be correct, but the two groups still guessed significantly differently (average age of 50 vs. average age of 67).

 

Some solutions/shortcuts to avoid this psychological pitfalls

The Warren Buffett Solution

Our favorite holding period is forever” – Warren Buffett

This is probably the most radical way to avoid a wrong sales: Don’t sell! Warren tries to focus on businesses that are so good that he never will have to sell them. If you never sell, you will never make a mistake in selling 😉

Of course there is a chance for a big Mistake of Omission (aka sucking thumb)

And as always, Warren Buffett don’t always follows his own rules. He and his stock-pickers (Todd/Ted) often** sell stocks (DE, WMT, T,) – but the big central positions of the BRK-Stock-Portfolio (WFC, KO, IBM, AXP) essentially stays the same. “When the facts change, I change my mind. What do you do, sir?” – John Maynard Keynes

This solution is not perfect, but focusing on good businesses that you can hold virtually forever may limits the activities that will take place – and therefore lowers the possibility of a dumb action. I think it’s a good way to eliminate mistakes.

**Some fewer known Berkshire-Holdings that were sold out; Data by Gurufocus (link)

2014 Express Scripts

2014 Starz

03/2013 General Dynamics

09/2012 CVS Health

09/2012 Dollar General

06/2012 Intel

09/2010 Home Depot

The Ben Graham Solution (kind of)

As I remember Graham used some kind of expiration date on his basket approach. Buy a basket of undervalued (lower than book-value) stocks and wait for them to reach their fair value. Sell them when they reached their calculated fair value or after two years. Two years should be enough for Mr. Market to recognize the fair value of a stock.

Of course Ben Graham was working in a different time. He could collect up the shards of the Great Depression in a big quantity. Deep value today don’t allows a portfolio of 30 promising positions.

By putting a “for Sale” sticker on them in mind it is harder to fall in love with his own stocks (Endowment Bias). I know this Idea aims in the opposite direction of what I called “The Warren Buffett Solution“.

I hope thoughts like that while buying a new stock can help making better decisions afterwards:  “Because of the good growth opportunities in the near future and the slight undervaluation compared to the peer group I’m planning to hold the stock for the next 5 years.”

The Eat-dessert-first method?

I like searching for new investment opportunities and expanding my horizons by analysing new companies that I don’t know. It is fun. Way more fun than looking at my holdings and analyse if something went wrong with them which the market hasn’t already discovered.  I know I should do more of that work.

By putting the buy of a new stock before the sell of an already owned – I hope I can eliminate the endowment bias. Also it would force myself to do the “unloved” task of choosing a candidate to sell from my portfolio.

 

Bottom Line:

I am not sure how I will act in the future and if this article will help me with that task. Of course I will (again) make mistakes in selling stocks, but I hope by making the task more structured I will eliminate some risks/errors. In conclusion this is my plan of how I will act in the future:

  1. doing more research on my already owned stocks
  2. establish a “do not touch“- basket of stocks (like WB)
  3. establish a “maybe for sale”-basket of stocks
  4. doing research on new companies
  5. when the research of a new company leads to a buy (maybe) I have to sell other stocks from the “for sale” basket to avoid a cash quote decline or a to big sector-concentration
  6. when buying a stock I will write down the reason I have bought it and how long I’m planning to hold it
  7. I will track my decisions (with a wish-list app) to make sure that my sold stocks don’t outperform my holdings

 

Additional Material:

Behavioral Bias on investopedia

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7 thoughts on “Random thought on selling stocks

  1. Another addition to your points:
    1. doing more research on my already owned stocks
    Do you have a research standard or a checklist? I am still working on this issue, but I try to gain a certain standard.

    2. establish a “do not touch“- basket of stocks (like WB)
    Good idea. I call them rejected stocks. They didn’t make it through quality control.

    3. establish a “maybe for sale”-basket of stocks
    Depending on what criteria?

    5. when the research of a new company leads to a buy (maybe) I have to sell other stocks from the “for sale” basket to avoid a cash quote decline or a to big sector-concentration
    What’s your basic cash level?

    6. when buying a stock I will write down the reason I have bought it and how long I’m planning to hold it
    A investment journal is a very good idea. It helps to keep focused.

    7. I will track my decisions (with a wish-list app) to make sure that my sold stocks don’t outperform my holdings
    Hm… so your plan is to improve decision making by this? I have the stance that I just forget about some stocks that I sold ;).

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    • 1. No, I don’t have a physical checklist which I go through. I have some points that I always check. Quality of Management (Shareholder friendly?), Quality of Business, Debt Level, Growth, Chances and Risks. I guess the checklist for already owned stocks would be quite the same.
      2. Sorry, I meant stocks that I already own and will not touch (like Coke for Warren Buffett) and hold forever (or let’s say very long). But your Idea also don’t sounds bad 😉
      3. I don’t know for sure now. Stocks that I don’t feel well owning now. The problem is that when things turn bad a sell doesn’t make sense to a depressed Mr. Market. On the other hand: “if you find yourself in a hole is to stop digging.”
      4. My cash level is at … honestly it’s at “don’t buy on margin” 😉
      5. This blog is kind of my investment journal
      6. I understand ;). But I want to track my decisions, which is harder for sells than for buys. Some of my sells were good (leave BHP and Oil early, hitting the brakes at WTW) some of them were not (selling MCD and buying Swatch for it, ouch). By knowing what happens afterwards I can learn from it.

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  2. 1. I am currently working on this issue: http://www.wertpapier-forum.de/topic/49837-checkliste/. It won’t be physical. A good article is this one: http://latticework.com/research-perspective-generals-and-specials/.
    3. Hm… this sounds a big cloudy. What are the reasons for not feeling happy on owning a stock?
    4. Low? 😉
    5. I don’t know if it is really good to have a purely public investment journal. There is much self-confidence needed to change an investment decision, that was made public before. It might be easier to be honest to yourseld, when you aren’t in a situation, where you might “loss your face”.
    6. Do you know rentablo? They have a nice function for valueing sell decisions.

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    • Hi ebdem,

      thanks for the links, I will look at them!

      3. I think it depends on the situration.
      4. Yes, maybe to low.
      5. You made a good point (it’s a psychological commitment which is realy hard to break). I will think about how I will handle it. But don’t posting about my mistakes feels wrong to me.
      6. Thanks, I will look at them. Do you use that tool yourself?

      Like

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