If you own an individual portfolio of stocks, one of the first things investors often learn (sometimes the hard way) is to sell your worst-performing stocks first and keep your best-acting investments the longest. In other words, sell your losers and try to turn your better stocks into your big winners.
General market corrections, or price declines, can help you recognize new leaders if you know what to look for. The more desirable growth stocks normally correct 1 1/2 to 2 1/2 times the general market averages. However, as a rule, growth stocks declining the least (percentage wise) in a bull market correction are your strongest and best investments and stocks that plummet are your weakest choices.
For example, if the overall market suffers a 10 percent intermediate-term falloff, three successful growth securities could drop 15 percent, 20 percent and 30 percent. The ones down only 15 percent or 20 percent are likely to be your best investments after they recover. Of course, a stock sliding 35 percent to 40 percent in a general market decline of 10 percent could be flashing you a warning signal and you should, in many cases, steer clear of such an uncertain stock.
Here is the legendary Jessie Livermore’s take on taking small losses, “Profits always take care of themselves, but losses never do,” he said. “The speculator has to insure himself against considerable losses by taking the first small loss. In doing so he keeps his account in order, so that at some future time, when he has a constructive idea, he will be in a position go into another deal, taking on the same amount of stock as he had when he was wrong.”
Unfortunately, many investors do the exact opposite; they sell their winners and keep their losers. This is usually due to the psychological tendency not to admit that one has made a mistake. By selling a losing stock, there is finality to the transaction. That finality translates into an admission that when you bought the stock you were wrong about its future direction. For many, as long as they hold onto the stock that admission never takes place, even though the investor may continue to lose money.
Quote of the Week: “Cowards die many times before their deaths; The valiant never taste of death but once.” — Percy Bysshe Shelley
Bart Ward is the chief executive officer of Ward & Co. Ltd., an Anoka-based registered investment adviser – specializing in the management of stock and bond portfolios in companies which are listed on the NYSE.