You'll Never Grow Rich Taking A Profit

Friday, Jan 31 2014 by
12

“I made up my mind to be wise and play carefully, conservatively. Everybody knew that the way to do that was to take profits and buy back your stocks on reactions. And that is precisely what I did, or rather what I tried to do.....

They say you never grow broke taking profits. No, you don't. But neither do you grow rich taking a four point profit in a bull market.”

Jessie Livermore, Reminiscences of a Stock Operator

Orgasmic Trades 

We hate taking a loss, so taking a profit is always good, we usually think.  After all, we’ve locked in our profits, so we can never take a loss on them.  Which is all well and good, if you have a continuous stream of brilliant investing ideas, such that you can replace the stock you’ve sold with one that’s better.

This is worse than loose thinking, it’s not thinking at all.  It’s not the profit we’ve made we should worry about, but the profit we’ve foregone.  It’s the opportunity cost of selling a profitable stock we should be concerned over, not the transient orgasm that comes with the brief thrill of a quick gain. 

“You never go broke taking a profit” is a horrible, thoughtless, dumb investing aphorism that deserves to be consigned to the Satanic fires along with tipsheets and day trading.  It’s true, of course, but it justifies a whole raft of otherwise indefensible, idiotic and perverse trading behavior.  ­ Worse still, it panders to one of our most fundamental behavioral weaknesses, loss aversion.  We just hate selling at a loss, so we will grimly hang on to loss making stocks. 

The disposition effect, which is an outcome of loss aversion, adds to this the nasty twist that we tend to sell our winning stocks too soon – which means we no longer run the risk of a loss on that stock (see Brains, Bulls and Lucky Tossers).  Of course, the problem is that we only track the stocks we hold.  So here’s a tip: keep tracking the stocks you've sold and see what the results are.  I can tell you one result – you’ll suffer from an alternative behavioral bias, regret. 

The general idea about these biases is that they cause us actual pain.  So selling at a loss hurts, and we…

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As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. The author may own shares in any companies discussed, all opinions are his/her own & are general/impersonal. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.


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4 Comments on this Article show/hide all

whitmad 1st Feb '14 1 of 4
2

I suggest that investors should read Daniel Kahnemann "Thinking Fast and Slow" for some interesting insights in the ways instinct undermines rational behaviour.

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Paul Scott 1st Feb '14 2 of 4
3

Hi,

I think what you've written is very true for traders, but not so much for value investors.
If an investment of mine goes down in price, then it doesn't bother me at all, providing I am sure that I'm right about the fundamentals being attractive. It might appear a losing trade in the short term, but to me it has become a bigger opportunity, so I re-check all my analysis, then buy more.

Also, some of the richest people I know always sell first, often way too early, banking typically a 30% gain every time. Work out what 30% gains are, compounded a few times! They are recycling money into better opportunities, so their compound gain is better than what the original stock did, even when it continued rising.

Regards, Paul.

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timarr 2nd Feb '14 3 of 4
5

Hi Paul

I completely agree, but you are not most people and I'd venture to suggest that neither are your rich friends.

The article, as are all I write, is based on research into the habits and behaviour of average investors, not some specific high functioning subset with the time and aptitude to develop an approach which limits the impact of psychological bias and which enables them to effectively recycle and compound their gains. I would guess that the silent majority who follow what you write are more typical of the average investor than you are. And for every one who reads and learns I bet there are ten who treat your analysis as a tipsheet.

In any case, have you ever compared the cost of selling to the gains you've made by recycling? It only takes one ASOS to make an investing career ...

Love your reports btw. Quite the best thing of their kind being written by anyone.

timarr

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elizabeth_grey 11th Feb '14 4 of 4

I suppose it depends on what the investor's perceived risk is - I imagine that perhaps for smaller investors it's worthwhile feeling that they're not taking a big risk to get rich, as they're happy with a lower risk portfolio in general.

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About timarr

Timarr

I'm a UK based technologist (career) and psychologist (academic) with a long-term interest in financial markets, with a particular emphasis (and skill) in how to not make money out of them. When I'm not working or blogging I'm to be found childminding, walking the dog or hiding in the garden shed with a good book :) more »


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