Devoted to understanding the basics and fundamentals of investing

When should I sell my winners and losers?

Studies show investors sell their winners too quickly and hold on to their losers too long.  When we buy a stock or bond, we pay a certain price for it.  We fix that price in our mind.  When the stock goes down, we often say that we don't want to sell until we can get our money back.  So, we hold on to the stock hoping that it will go back up so we can sell it.  The consequence of this is that we frequently end up losing even more money than we would have if we had sold earlier.

On winners we have mental targets for how much we want to make, say 5% or 10%.  When the stock gets there, we sell it to lock in our profits.  The consequence of this is that we frequently leave money on the table.

Academics tell us that we fear or dislike losses more than we desire gains. 

So how do we avoid this behavior?  For losses, we can use trailing stop loss trades to sell us out of a losing position.  You would look at the purchase price and the normal daily volatility of the stock.  Then you would set a stop loss just outside the daily volatility amount so that it is a loss that triggers the sale and not just normal daily movements.  As the stock goes up, you move the stop loss with it. For winners, you can pursue a similar strategy.  You let winners continue to run with a trailing stop loss.  If you get nervous, you can move some portion of the stop loss inside of the daily fluctuation so that you gradually take money off the table.

So, remember two rules of thumb.  The first comes from retail sales.  It says, "Your first loss is your best loss."  Sell out of your losers early.  The second comes from horse racing.  It says, "Let your winners run."  Follow these two rules using stop losses and you will have more money at the end of each year.