We’ve heard it before and it is said in almost every investing or personal finance book out there; don’t fall in love with a stock. I’m sure most of us have been there before, I know I have. You have purchased a new stock or mutual fund and you are just sure it is going to turn out to be a great investment. As time goes on, you become more attached to it, making excuses for why it is performing how it is (good or bad). You would think that it is easy to stay objective when looking at investments, but often we still become attached to them. Why is that?
Many people think it has a lot to do with ego. When looking for a new investment we spend a lot of time doing research and digging through hundreds or thousands of other investment options, looking for that one gem. Once we find this special investment and make the purchase, we become tied to it sub-consciously. With the time and effort we have invested into choosing the right investment, we are just sure it is going to be the one. As you hold the investment you watch how it performs, when it goes up, you congratulate yourself on a good decision, and as it goes down, you reassure yourself that your decision was good and it will only be a matter of time before it starts going up again.
Unfortunately, this subconscious attachment to our investment can cause us to overlook more important information that should be used in deciding the true fate of the investment. When the stock is performing well we can be so proud of how it is doing that it is easy to overlook points on when to take money off the table and lock in profit. Just as missing out taking profits, we can miss signs on when to sell a losing stock. We are human, we don’t like to be wrong, and selling a losing investment can feel like defeat if we are emotionally tied to the investment.
So how can you detach yourself from your investments? The key is setting goals and sticking to them. Before making a trade set out definitive investing guidelines and stick to them. When you use hard and fast numbers and objectives you can take out some of the emotion. For example, pick a downside point, such as 5%. If your position is down 5%, get out and move on. Also set an upside target for pulling out some profit. When this number is reached, do what you initially set out to do. Aside from setting rules for your investment, here are some general guidelines to follow as well when dealing with an individual stock:
- Don’t buck the trend. Follow what the broad market is doing, as well as the sector of your holding. More often than not, if the market and sector is doing one thing, your individual holding will to some extent follow suit.
- Be careful when the stock is reaching a 52-week high on relatively light volume. Could be a sign of a collapse in stock price.
- Sell into a run while demand is high. Waiting for the absolute top can lead to chasing it on the way down.
- Use a stop-loss order to protect against excessive losses.
Of course, following these tips are always easier said than done, and I’ve been guilty of falling in love with some of my holdings as well, some of which have cost me dearly. One example of this happened a few years ago, I had stumbled upon a small company that was poised to release some new technology and had a very promising outlook for the next few years. I did my research, the price seemed good, so I purchased some of the stock. It didn’t so much for about 6 months, I was up around 3%, so I contently held on. Then the news started to hit, they had secured a big order, the stock made a run. It was up about 20% after a few weeks, I was thrilled. All the while, the company was continuing to release little bits of news that continued to keep the stock price high. It maintained this level for another few months, but I still did not take any profits off the table, I just knew it was going to go higher. Sure enough, they released some new technology at a technology fair, and the stock ran again, and again. Over the course of the next 6 months, it continued to go higher and higher, and I was so proud of my foresight in picking this stock when it was so cheap.
At the peak, I was up nearly 500% and had yet to take any profits. I was so caught up in the great news and continued run I just didn’t want to miss out on any further gains. That is when problems came up. An order was canceled, the latest quarterly reports showed a sharp decline in revenues, and as quickly as it went up over the past year, it began to go down. Did I take any profits? No. I rode it down to where I was up only 100%. Yes, I still had doubled my money, but that wasn’t good enough I kept telling myself, just a few weeks ago I was up so much more, I can’t settle for this. Well, the stock eventually started trading in a range again, and I was up a good 25% before I finally sold most of my holdings. It came down further and I ended up selling the rest at a loss.
This was a painful lesson. If I had followed some investing rules I had set prior to even placing the trade, I could have locked in substantial gains over the course of the long run, eventually leaving myself in a position where I recovered all of my principal and let the gains ride. So after all said and done, I ended up only just barely breaking even over the course of close to 2 years with this company, all because I became attached to the company to a point that it clouded my rational thought and hard numbers.
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About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning Counselor® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.