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Timing when to sell stocks
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September 20, 1999: 8:07 a.m. ET
It's important to have a sell strategy, but many trade too much or too soon
By Staff Writer Alex Frew McMillan
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NEW YORK (CNNfn) - Sure, there's lots of advice on when to buy individual stocks. But the big question is how do you know when to sell?
"It's a good question," said Charlie Rice, president of Rice Money Managers, a market-timing-oriented investment company in St. Louis. "The selling is as important as the buying -- success demands an exit strategy."
But Rice thinks many individual investors have become lax about answering it, given the good performance of stocks this decade. "People are fairly complacent about different kinds of buy and hold strategies because the market has been relatively benign from 1994 to today," he said.
Each investor has his or her own goals, and individual circumstances vary greatly. But stock gurus say selling is many investors' greatest weakness. Most people sell too early, and without a clear idea of why. Developing a good sell strategy is important for investing in equities, and something to stick to, investment professionals say.
Let why you bought be your guide
"On the whole individuals don't have a well-defined philosophy, so they don't know exactly why they bought and they don't know when to sell," said Maria Scott, editor of the AAII Journal, put out by the American Association of Individual Investors.
She recommends letting the reasons you buy a stock drive the decision to sell, selling when they're no longer true. "Are you buying undervalued stocks, or stocks for growth reasons? Once you've developed that philosophy it becomes reasonably easy to decide to sell."
You might notice that a stock you bought for value has become overpriced, or that a growth company may have gone through the business cycles that made it grow quickly. Of course there are still tax considerations and transaction costs that might make selling at a certain point less attractive, Scott added.
Most individual investors should think of holding stocks for at least two to five years, longer for a "buy and hold" strategy, she said, and she encourages people to think long-term. Selling itself isn't the problem for most investors. Selling at the right time is. "Most people tend to sell too quickly rather than too slowly," she explained.
Most people sell too early, and too often
Two studies by Terrance Odean, an assistant professor of finance at the University of California at Davis, back her up. By analyzing results from a discount brokerage, he has concluded that most investors sell out of positions too quickly, and they turn over their accounts too often. It hurts their performance. "For most investors, the more they trade, the worse they do," he said.
And Odean has found that individual investors buy and sell a lot. The average stock-trading household turns over a rather amazing 75 percent of its portfolio each year. That's only likely to increase. Online brokerage customers in particular, lured by lower commissions, ease and excitement, are increasing the amount they trade. But they trade more speculatively and less profitably.
Odean discovered that people tend to sell stocks that perform better than the ones they buy, replacing stocks that have been rising with worse ones. That's one reason why over one five-year period that he looked at, investors that traded frequently generated returns of 11.4 percent vs. 18.5 percent for infrequent traders.
The average investor ended up under-performing the market thanks to over-confidence in their ability and reading the wrong signals to sell. Investors aren't just victims of poor market timing, getting in and out of the market at the wrong time. It's clear they're picking the wrong stocks to sell, and replacing them with ones they shouldn't buy, misinterpreting information they have.
Brad Barber, a UC-Davis associate professor of management, worked with Odean on one study, Trading is Hazardous to Your Wealth. "If you could figure out how investors are making their decisions and do the opposite, you would make money," he said. "They seem to have perverse timing."
What can you do about it?
To see if you're making the wrong sell decisions, James Cloonan, chairman of AAII, suggests setting up a "sell portfolio." Keep a record of the stocks you've sold, treating the sell price as the buy price, and keep tracking them. That way you can evaluate whether you're selling at bad times and see if you need to rethink the way you decide to sell.
Scott, the AAII Journal editor, polled 10 investment gurus - including Warren Buffett, Peter Lynch and T. Rowe Price -- on their investment approaches, including when to buy and sell. Their buy criteria differ substantially, but most agreed investors should hold for the long term. Most recommend selling when the original reasons for buying the stock no longer apply.
Some investment professionals lean toward technical analysis as a way to cut losses. Investor's Business Daily founder Bill O'Neil believes you should sell if a stock falls 7 percent to 8 percent below your purchase price, for instance.
Hugh Johnson, chief investment officer at First Albany, agrees that technical analysis is important. "My view is you should never ignore the price of a stock," he said. But it's of most use to performance-oriented investors, and not for people who buy on sound fundamentals and hold five to 10 years, "which is probably the best way to invest," he said.
Still, watching the declining price of stocks such as Oracle would have alerted investors to macro-economic problems in Asia well before most U.S. analysts and investors realized they would hit the company's earnings, Johnson said. He suggests developing a moving average for each stock and watching whether the stock dips below it. Relative performance, comparing a company you hold with its peers or an index, is another popular way to look for weakness.
Stocks that have started to drop do tend to continue to decline, and stocks that start to go up tend to continue to go up, Barber, the UC-Davis professor, conceded. So technical analysis is a useful tool once you've reached a sell decision. He added there's evidence that following consensus analyst recommendations, and selling stocks analysts are bearish on, also bears fruit.
But Barber still said most people are too hasty in selling stock. The most rational reasons to sell, he said, are because you have stock losers and you're taking a tax loss, you're restructuring a portfolio, or because you want to take money out for your own use.
"If you need some money and you need to sell, sell those that have started to slip a little," he said. But it doesn't make sense to use active trading strategies, trying to time the market or follow short-term trends, he said.
"I don't think the average investor should pursue active strategies," he said, which leads to speculation more than investing. Look to cut losers for tax purposes, think long-term and take out money when you need it or to rebalance your risk, he advised. "Beyond that most people should leave it alone."
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