When to Sell Stocks - a technical perspective

Wednesday, Feb 01 2012 by
When to Sell Stocks  a technical perspective

Knowing when to sell stocks is one of the most difficult aspects of investing. While there is no shortage of advice on buying strategies (whether value, growth or momentum), there's a lot less written by those in the know about how investors can apply some logic to their selling decisions. Even the great and prolific Benjamin Graham seems to have been fairly quiet on the subject, other than a brief reference to selling after a price increase of 50% or after two calendar years, whichever comes first. As a result,  many investors simply don’t have a plan in place to preserve capital and/or lock in profits. Instead, they are often swayed by fear of loss or regret, rather than by rational decisions designed to optimise their returns.  

Fighting Loss Aversion 

Studies show that, when making money on a trade, people often take profits early to lock in the gain but, when losing money on a trade, most people choose to take the "risky" option by running losses and holding the stock. Unfortunately, good investors usually do the exact opposite - they cut their losses and run their profits! The explanation for our generally irrational behaviour relates to "loss aversion", i.e. the fact that people actually value gains and losses differently. Behavioural studies have shown that losses have more emotional impact than gains and are weighted more heavily in our decision-making (some studies suggest that losses are twice as powerful, psychologically, vs. gains).  

To counteract this tendency, one option is to adopt a mechanical selling strategy based on strict rules (i.e.  a system of stop losses). One interesting mechanical approach is set out by American fund manager William O'Neill of Investors' Business Daily (IBD) as part of the CAN-SLIM method advocated in his best-selling book, "How to Make Money in Stocks". As O'Neill is a growth/momentum-focused investor, his system makes most sense in that context but there are some general principles that are certainly of wider interest. 

Cut your losers 

First of all, O'Neill notes that losses are inevitable for any investor and must be faced up to - "the first rule for the highly successful individual investor is . . . always cut short and limit every single loss". However, he notes that, to do this, takes never-ending discipline and courage. He cites Bernard Baruch, a famous Wall Street operator…

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3 Comments on this Article show/hide all

fahrhb 16th Jan '16 1 of 3

I traded CANSLIM in 2013 and it worked like a dream , primarily because of a stong backdraft.
I gave a third of my gains back in 2014, primarily because of a the 8% stop loss. Nearly every stock went on to recover and get reasonable gains. The market was too volatile for this at the time.
The conlcusion I have drawn is only to use canslim in strong market uptrends, which are only about 15% of the time.
It may also interest readers to know that in backtesting of 100s of trading systmes, James Altucher found that automatic stops degraded every single one.

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herbie47 16th Jan '16 2 of 3

I don't know if Wall Street is different from the FTSE but if you had a 7% stop loss in many UK shares you would be bounced out on many and its not true you will only lose 8%, with spread, stamp duty and dealing costs it would be more like 12%. In uk a stop loss of 15-20% is more usual. Also stop losses don't always work, they are not guaranteed, if a share falls quickly say a bad profit warning, it will go through the stop loss and you may lose 20% or more. Occasionally I do you narrow stop losses, for instance recovery shares.

As he says its more a bull market strategy.

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Tom Firth 16th Jan '16 3 of 3

I agree that 7 or 8% is a very tight stop but the often missed point about the CAN-SLIM strategy is how much O'Neil talks about market timing. He's a big advocate of chart reading and spends about a third of his book 'How to Make Money in Stocks' talking about waiting for cup and handle patterns to complete etc before buying.

Given this emphasis on timing, his thinking is that if he's right the stock should be going up straight away and if its going down at all (he suggests getting out at even 3 or 4% down if it seems appropriate) then his idea was wrong.

I'm not an advocate myself but I think this goes some way to explaining why he sets his stop so unusually close. He also makes far fewer trades than a lot of the Growth/Momentum strategies and tends to have very concentrated positions. In the book he talks about an investment fund he set up with some students using $100 each of their money or something and lists all the trades for a few years. There's only 30 or so transactions for that period and that includes the sells and pyramiding successful positions!

Not for the faint of heart in my opinion...


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