DIY Investor Magazine
/
2015 Issue
25
MISTAKE 2: SELLING A STRONG SHARE WITH THE
AIM OF BUYING IT BACK LATER AT A LOWER PRICE
Closely related to the timing mistake is the attempt
made by some, possibly over confident, investors to sell
a strong share, with the aim of later picking it up after
a price correction and thereby running a big risk of
exiting the share for good.
In fact, these investors are trying to do something that
is twice as difficult as selling at a peak and buying at a
bottom:
1.
They have to sell the share close to a peak, but if
they sell the share before it’s reached a peak, they
often refuse to buy the share back above the sale
price because this is viewed as locking in a ‘missed
profit’.
2.
Even if the sale turns out well and the share
corrects, they still need to buy the share back close
to a floor; many investors think that the correction
will be much greater than it actually is and so they
wait too long to buy the share back. Once the share
starts climbing again (and rises back above the sale
price), they’re anything but keen to buy it back.
MISTAKE 3: NO ONE HAS GONE BROKE BY TAKING
PROFIT
This conventional wisdom is as old as the stock market
itself and follows seamlessly on from mistake 2.
Of course, it sounds logical: if a share has performed
well, it makes sense to secure the profit so that it can
no longer be lost. In addition, many investors are under
the unconscious impression that strong performing
shares have ‘used up’ their upward potential, so it’s
plain to them that they should be replaced with shares
that still have upward potential.
Top investors consider this stock market truth to
be nonsense; the exceptional performance of their
portfolios is often attributable to a limited number of
shares that have performed particularly well and that
they’ve been holding for years, if not decades.
Warren Buffett, left, who
has achieved an average
annual return of about 22%
since 1957 (12% better per
annum than the S&P 500)
can mainly thank around 15
shares that he has held on
to for many years for this
exceptional performance.
Shelby Davis, who managed to turn $100,000 into
$900 million over his 45 year investment career, could
attribute that exceptional performance to a handful of
shares that he kept for a number of decades.
It is furthermore remarkable that even many successful
traders say that their outstanding performance is due
to a limited number of shares that they’ve held on to for
a long time.
There’s nothing all that wrong with taking profit on
shares that have risen sharply; indeed, it makes sense
to sell shares that have risen so spectacularly that they
are (heavily) overvalued. However, systematically selling
off just any strongly performing share for the sake of it
makes no sense at all.
The share price of an exceptional company should
perform outstandingly well on the stock market.
But this doesn’t automatically imply that the share
is overvalued. Serious investors take changes in the
share’s intrinsic value into account and compare that
with its price on the stock market. It’s only when a
discrepancy arises between the two that a sale is
advisable.
Thus, it’s a far better stock market truth, which top
investors stand behind: ‘hold strongly performing
shares as long as the company continues to perform
well and as long as the share price does not get
(too far) ahead of the results.’
In Part 3 later in DIY Investor Magazine I look at two
more harmful buying and selling mistakes.
Shelby Davis, who managed to turn $100,000 into
$900 million over his 45 year investment career, could
attribute that exceptional performance to a handful of
shares that he kept for a number of decades.
