Selling Stocks Short: Get the Emotions Out of Your Decisions

Selling Stocks Short; March 30, 2008

I’ve never been a big proponent of emotion investing, but given the number of phone calls this past week, I thought now might be a good time to address it.

Buying stocks is pretty easy. People do it all the time. Knowing when to sell is something else entirely and most investors miss the boat on this one. The talking heads remind us daily that selling shouldn’t be an emotional process. No kidding.

(Note: Most of the talking heads don’t own any stock or mutual funds at all. Those that espouse the most are ones who have their money in money market funds and CDs. They want you to heed their wisdom, but these folks don’t eat their own cooking.)

Professional traders and investors use an array of tools to set selling objectives. Sometimes they work and sometimes they don’t. Trust me – I know this from experience. I’ve had a number of stops jumped recently and have the scars to prove it. I use a number of charts and technical indicators to set selling points on both positions and the entire portfolio. Sometimes this works like a charm and sometimes it doesn’t. The one thing that I don’t do is to let my emotions get in the way of things. I trust the numbers – period.

Everyday investors don’t have the luxury of knowing what I do, nor do they have my experience. When emotions enter the fray, they wreak havoc on a portfolio. The two most dominant emotions people have are fear and hope. When it comes to deciding whether to hold onto a stock or to get out, fear and hope are the worst of all combinations.

If one of your stocks is losing money, you have two options – hope it turns around or be afraid of losing more money. The thing to do is to cut your loss and wait for a better opportunity to present itself.

If one of your stocks is making money, you have two options – hope to keep making money or be afraid that you’ll leave points on the table by not getting out at the top. The thing to do is hope that you keep making money.

The idea in all of this is to get out of stocks that are falling and to stay in ones that are rising. The problem is that this is easier said than done because a winner that stops going up causes you to fear losing money.

So the question is this – how do you separate your emotions and your investment portfolio? I’m not a psychologist or a behavioral scientist. I am a student of human behavior. If you want to keep your emotions out of your investment portfolio, consider the following:

1. Step one is to get to know the face in the mirror. It’s the one with wrinkles and blood-shot eyes looking back at you every morning. That’s your best friend and your worst enemy. How emotional are you? How much risk do you really want to take? In other words, how much of loss can you take before you walking the halls at night screaming like a land starved longshoreman?
2. Make it hard for you to screw up. If you use a broker, place sell stop orders with them in advance. If you trade online, use GTC (good-till-cancelled) orders. If you place the orders in advance, don’t change them. Also, give yourself plenty of room to maneuver. In days of yore, it was common to use stops of 5 to 7 percent. With today’s gyrations, daily moves of 12-15 percent aren’t uncommon. If your stops are too close, you’ll get stopped out prematurely – leading to too much trading activity.
3. Understand this – THIS IS YOUR MONEY THAT YOU ARE DEALING WITH. It’s your future and your families. If you don’t keep your eye on it, know one will. The more you know and understand what you’re doing, the more successful that you’ll be.

You need to know the upside potential, the downside risks, how will my portfolio behave if interest rates go up or down, what happens if the dollar gets stronger or weaker, and a host of other things. Do you need to be an expert? No you don’t. But, don’t be in the dark either. Your cousin’s latest tip or the one from the guy with the awful necktie at work don’t cut it. That’s not a strategy – it’s a bet. Ordinary people don’t win many bets. If you don’t believe me, just hop a plane to Las Vegas, Reno or Atlantic City.

Look – I’ve been in this game since 1982 and this is a fact - your emotions will either make you or break you. It’s that simple. You will never conquer all of your emotions, but you can get your arms around them. Stock trading isn’t about picking the right stocks – that’s a really small part of the overall picture. It’s about coming to grips with your hopes and fears. Once you have your emotions under control, you’re well on your way to being successful.

Investing isn't about conquering your emotions. It's about handling them. If you have a handle on your emotions without using any of the above tools (or other tools of your choosing), you're the rare investor indeed. As for the rest of us, letting our money management and investment tools guide and control our financial decisions is a necessary step toward successful investing.

RAC
The Intelligent Trader