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When Should You Sell? | 7 comments | Create New Account
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When Should You Sell?
Authored by: martingale on Thursday, December 30 2004 @ 08:02 AM EST
Hi Anonymous:
    This strategy seems to imply that all investments will continue to rise in value over time.
No. Just that all investments are fairly valued at all times. If your investment falls in value that is because bad news has come out about the company. Given that news, the new price is a fair price. You have lost money, but since the price is still fair, there is no reason to sell.
    What happens when you buy a stock and the reasons for your purchase have suddenly changed?
The unquestioned assumption you are making here is that your "reasons" for purchasing the company were sensible in the first place. If you think you have some innate stock selection ability you are fooling yourself. Study after study has shown that even the best professional managers cannot pick stocks effectively: throwing darts at a newspaper was as effective. If the best managers money can buy cannot pick stocks effectively despite their enormous resources, education, and supposed skill, then what makes you think you can?

Next, if your reasons result in essentially random stocks, and your reason changes, then you will have exchanged one randomly selected stock for another. The expected return on a randomly picked stock is the average return. Fine. But the expected return on trading random stocks is the average return minus your trading costs. So you have cost yourself money and in exchange received nothing.

    The company that goes bankrupt doesn't care that you're blissfully ignorant of its impending demise.
Suppose you buy a company by "reason" of it having strong fundamentals. You pay quite a high price for a company like that. Next, surprisingly, the company reveals that there has been a massive accounting fraud and actually the company is nearly bankrupt. The price naturally drops. Are you telling me that the new, very low price is now somehow not a fair value for the company? Clearly it is a fair value! It's the fair value for a company that verges on being bankrupt. It's unfortunate that you picked this dog, but that's all water under the bridge, you have already lost that money. Looking dispationately at the current situation you have a reasonable investment in a risky company.

You could sensibly argue that you had wanted to be a conservative investor, and did not want to hold highly risky company. Note that your holdings in this company have significantly decreased! Whereas it used to represent 10% of your portfolio its fall to 1/10th of its old value means it now represents just 1% of your portfolio. Hardly much of a risk for you now!

That may seem funny to you but please give it a lot of thought. Your error is in overlooking that money lost is already lost.

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