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~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ 20 September 2006 Table of Contents (1) Quote on Fear (2) Article - The Problem with Selling - Part 1 (3) Trading Forum - Stock Meeting Place (4) Website Update ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Stay up to date with all that is happening at Trading Plan, by subscribing to our 'Trading Blog' (no email address necessary). I am continually adding content and every update of this site is announced here, including minor content updates, page additions, and product releases. So stay plugged in by subscribing to this site's RSS feed. Copy and paste the address below into your RSS reader to receive the Trading Plan RSS feed... http://www.trading-plan.com/Trading-Plan.xml Not sure what RSS is? ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ -- 1 -- Quote on Fear "You gain strength, courage, and confidence by every experience in which you really stop to look fear in the face. You must do the thing which you think you cannot do." Eleanor Roosevelt (1884 - 1962). -- 2 -- The Problem with Selling - Part 1 ‘Exit, pursued by a bear’ from ‘The Winter’s Tale’, William Shakespeare We have each experienced at some time, usually early in our investing or trading activities, what is known formally by academics as ‘the disposition effect’. This is the phenomenon of holding losers too long and selling winners too early. We are all predisposed to dislike incurring losses much more than we enjoy making gains. Consequently, we are willing to gamble with losses and to hang on to stocks that have lost value (relative to their purchase price), while being eager to sell stocks that have made money. The disposition effect is probably the most common problem for new investors and traders, and certainly one of the most closely studied. This article looks at the holding of losers for too long or, to put it another way, the problem with selling. It examines some of the pressures on us to hang on to losing stocks in the current market, what we can do to overcome this tendency and to become better investors. While much of this is applicable to selling down your portfolio if the market is topping, this is not the principal area that we are addressing. While the attitude of some people to money and its acquisition and disposal borders on the pathological, I want to keep this treatment relatively simple and deal with the every day tensions that we all experience. To this end, we will look at the pressure of ‘not selling’ from our providers, from the market and, most importantly, from ourselves. Pressure from the Providers ‘If you see a banker jump out of a window, jump after him – there’s sure to be a profit in it’ Voltaire, French philosopher and writer Today’s provider in the investment industry is a forceful salesperson who wants you to buy something. Competition from online broking has squeezed margins for traditional stockbrokers, while many investors now do their own research, use technical analysis to reduce trading costs and no longer pay full-service stockbrokers a premium price. The online brokers, however, now include major banks with their new markets in ‘wealth management’. The banks offer a one-stop-shop approach to online banking services, which includes share broking. They either own or provide the principal access channels to most online broking platforms and their related application software. In a market that is awash with superannuation funds, there is also a far more extensive range of products for you to buy from the banks and others: derivatives, hybrids, CFDs, Listed Property Trusts (LPTs), Listed Investment Companies (LICs), (often with margin facilities) and hundreds of managed funds. These are touted by an army of financial advisors and others anxious for you to buy their products. A wider market with more products has led to a ‘canned pitch’ approach, especially through television. This ensures consistency and the avoidance of possible litigation through wrong or poor advice. The canned pitch has led to greater persuasion and persistence techniques, where the unchanging theme is buy, buy, buy. Meanwhile, there is a range of euphemisms from the brokers to avoid using the word ‘sell’. The following words are usually – but not always – code for the terrible ‘S’ word: hold, accumulate, long-term buy, market performer, market weight, perform in line, underperform and underweight. A famous code phrase (which allegedly cost the analyst his job) was ‘can’t recommend a purchase’. Melbourne stockbroker Marcus Padley had a piece entitled ‘There’s no upside to telling clients to sell companies’ in the Melbourne Age (local newspaper) recently. This provides cogent reasons (from the other side of the fence) as to why you are unlikely to hear ‘sell’ from your broker. While this isn’t direct pressure on us not to sell, it does create a climate where the implications of sometimes having to sell are not addressed adequately in investment structures. We are all subjected to the conditioning process which recognises that every buy we ever make is done with optimism and an expectation of success. The selling process, however, is tacitly ignored. The knowledge that a ‘sell’ may conclude something that was unsuccessful, and indicate that we might have made a mistake, does not reinforce the continuing ‘buy’ message. Pressure from the Market ‘We don’t trade the market, we trade our beliefs in the market’ Van Tharp, US psychologist and author. The market, of course, brings no pressure in or of itself. It is the perceptions or beliefs we have of the market which cause selling difficulties. New players see clear causal relationships in the way the market acts, and think that every reason should result in a single possible outcome. It quickly becomes apparent that the price reaction to any given event is likely to vary widely. We respond similarly when we first start out by expecting every trade to be a winner. Even if we religiously follow whatever ‘rules’ we have learnt or been taught, our trades can still fail. Everything may indeed be right by ‘the rules’, yet the trade fails because the market only ever works in probabilities and never in certainties. We learn the hard way that right action doesn’t necessarily result in a profit. No matter who advised you or how good the setup or entry signals may look, a trade or investment can fail. There is no possible way to predict the outcome of any particular position which is taken, and the only weapon in our armoury is the Stop Loss (SL). However, to sell on the SL involves change, and change can generate anxiety and fear. Anxiety is experienced as a vague sense of alarm, while fear usually has a specific action connected to the emotion. In practice, fear and anxiety usually overlap. While fear may drive the individual to sell, anxiety provides for no easy solution other than to just hang on, hoping that price will improve. This also avoids having to confront a third, and sometimes keener emotional reaction for market participants and that is, regret. To avoid regret, investors and traders are reluctant to admit the error of buying a poor stock. And to avoid validating that regret, investors will defer selling shares that have gone past their SL, which only compounds their mistake and adds to their loss. Hanging on in this manner is also a form of ‘mental accounting’, where the investor looks at each position individually and frames their view of a gain or loss around that individual decision rather than looking at their overall wealth or the success of their overall portfolio. It is a giant step forward when the investor or trader each looks at the bigger picture, accepts complete responsibility for their actions and recognises that some losses with individual positions are inevitable and can not be avoided. Owen Richards is a member of the Australian Investors Association (www.investors.asn.au) and this article first appeared in the AIA Equities Bulletin in May 2006.
-- 3 -- Trading Forum - Stock Meeting Place I now frequent and contribute to the online trading forum called Stock Meeting Place. Membership is easy and free. You can come along and ask any trading question in one of the numerous sections of the forum and receive a helpful response from one of the many members (approximately 2000). This forum is the only place online where you will also find Daryl Guppy, the well known trader and author. Remember, there is no such thing as a silly question so visit, sign up and ask a question. Visit http://www.trading-plan.com/trading_forum.html for more information. -- 4 -- Website Update Over the last couple of weeks new information has been added on trading options. Visit http://www.trading-plan.com/options_general.html to view the new options section. In the next couple of weeks, more articles will be added in the options trading section on topics like Limited Risk, Time Decay, Volatility, and Option Mispricing. If there is anything you want to learn about specifically with regards to trading, do not hesitate to contact me. Contact details are at http://www.trading-plan.com/contact_us.html ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
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