01Following the crowd during a correction
The two emotions most responsible for investment losses are fear and greed. The former is especially dangerous for investors who buy retail stocks, which are sensitive to consumer spending and the economy. When the market thinks the "sky is falling" good retailers are lumped in with struggling ones, and the whole sector plummets further than the market as a whole. In theory, this creates a wonderful buying opportunity for high-quality retail stocks but in reality, most of us give into the pain of stock price declines and sell at a loss.
This selling error was on full display during the crash of 2008 and the years that followed. Along with the truly awful retailers (I'm looking at you Borders), some wonderful retailers were thrown in the trash bin, such as:
- Amazon.com: stock price on Jan 1. 2009: $58.82. Today: $426.95.
- Costco: stock price on Jan 1 2009: $45.03. Today: $138.78.
- Home Depot: stock price on Jan 1 2009: $21.53. Today: $110.37.
These examples are noteworthy because, in each case, the underlying businesses of the stock in question was doing relatively well. Yet, many investors chose to follow the crowd and sell because they couldn't handle the short-term volatility. What was a once in a lifetime buying opportunity was missed by many, as panicked investors fled great businesses.
Studies actually show that our tendency to sell low is directly linked to poor investor performance. Yet, despite knowing this, we still do it because our brains are hard-wired to follow crowds (especially during times of uncertainty).
If you're able to hold onto high-quality stocks during market panics, you'll have a greater chance at high returns. So try your best to make selling decisions based solely on facts and the performance of the business behind the stock. Never make selling decisions based solely on a declining stock price, and never invest money that you need in the next five years.
02The price is too high
Believe it or not, one of the most common investment mistakes is selling winning stocks too early. Usually, an investors rationale for selling winners sounds like this:
"I always sell my stocks after they double in price"
"I'll sell because I want to lock in the gain before the stock pulls back"
"I'll sell because the stock has already tripled and can't go higher"
Selling a winner sure feels good, because you think you're booking a win. But, as we see so often in retail, a great stock can and will go up indefinitely. Think about it: Amazon.com, Walmart, Home Depot, Chipotle, Nike, and countless portfolio transforming stocks all had their best gains after their share price doubled from their IPO.
Winners and losers just don't regress to a statistical mean; that goes for retail businesses and stocks. The winners beat the losers, steal their market share, and do even better because they have less competition.
Selling a stock that's on its way for a 1,000% gain, when its racked up a 100% gain, feels a lot better than having a losing stock go to zero. In reality, it's much worse because the stock that goes to zero only loses 100% (on the winner, you'd have missed out on 900% of gains). Time and time again, I hear traders bragging when they dive out of the market and miss a 10% correction. But these folks tend to remember only their good days, rather than all of the rallies they've sat out. The truth is that the majority of the markets gains come from a handful of days--days that are missed by market timers trying to "lock in their gains."
It's just impossible to have a market-beating portfolio if you sell the best businesses you own before they've reached the height of their powers. There just won't be enough great other stocks to put your money toward. So focus on business fundamentals, again, rather than any stock price movement (up or down) and when a business is gaining steam, hold on!
The Dumbest Reasons to Sell a Retail Stock
Focusing on price, rather than business performance, leads to selling errors.
One of the hardest decisions for any investor to make is choosing when to sell a stock. Part of the reason it's so tough is because the topic is just not covered often enough. Think about it, most investment training's and books discuss buying: when to buy, what to buy, even where to buy a stock is covered. But selling? It's still treated as some sort of dark art, with rumors and gut instincts guiding most decisions.
Unfortunately, selling errors account for just as many investment losses and missed opportunities as buying errors. Like all investment decisions, you need to have rules for selling so that your gut and emotions won't betray you in crunch time. These will especially bite you with retail and consumer goods stocks.