In its simplest form, trading consists of just two decisions: when to buy and when to sell. The buy decision is the easier of the two but is discussed to a much greater extent than selling. Buying holds the promise of significant profits and that makes it a preferential course of action.
Selling is not nearly as fun. When a trade does not go as planned it is a clear admission of failure. When you lock in a loss you must admit that you made a mistake and were wrong. Many market players go to great lengths to avoid that situation. They simply hold on to a losing trade as it continues to sink with some vague hope that it eventually will come back. The cold, hard truth is just too hard to admit.
Even when you are selling a big winner it can be a source of negative emotions. Many market players become emotionally attached to stocks that have treated them well over the course of many years. Apple (AAPL) , for example, is a stock that many people will continue to hold, even though they have better opportunities elsewhere, because of their emotional attachment. (Apple is a holding in the Action Alerts PLUS portfolio co-managed by Jim Cramer.
Buying is a positive event while selling stirs up mixed feeling at best. That is exactly why we need to expend far more effort dealing with selling than buying.
Selling ultimately has much more impact on your results than buying. Many advise simply doing away with it and holding for the longer term. They argue that because the market has an upward bias over the very long term the odds always will favor simple holding. When you figure in taxes, transaction costs and other issues, why even both with selling? Buy-and-hold has worked very well since the Great Recession of 2008-2009 and there is now more money sitting in index funds and passive funds than ever before, so forget selling and just keep on buying.
The problem, of course, is that we are fallible. We won't always buy the best stocks and our timing may be terrible. Many of those sitting in passive funds now have never experienced a real correction and they are going to find it extremely uncomfortable when they lose years of gains and are told to wait patiently because the market is sure to come back.
Another issue to consider about selling is that those who advise against it usually are not objective. Fund managers, brokerage firms and money managers don't want you to hold cash because cash is too easy to move. Their business is gathering assets rather than producing returns. People in the investment business make money based on the amount of assets they manage rather than the returns they can deliver; therefore it is better for them if you simply stay invested at all times.
Our psychological makeup tends to push us to do the exact opposite of what we normally should do when it comes to selling. There is a tendency to hold on to bad trades as we hope that they work while there is a tendency to quickly lock in gains on good trades so we can feel good as we proclaim victory Rather than cut losses quickly and let winners run, we are inclined to do just the opposite.
We need to be very aware of that natural inclination by directly confronting the major challenge that the sell decision presents. The key is that we must distinguish between normal volatility and a change in trend. To a large degree this is a function of time frame, but it is a problem that never goes away unless you simply buy-and-hold forever.
What makes this issue much more difficult is that "normal" volatility is always shifting. Some stocks have higher betas, which means that on average they move to a greater degree than the indices, but even that can change over time.
Also, different markets will have different levels of volatility. Recently we have had a run in the indices where there was no move of more than 1% for weeks. That was unusually flat and made it easier to set fairly tight stops and not be shaken out of good trades.
There is no perfect formula for setting stop levels on trades, and what works best one day will be a total bust the next. What is important is to know that your sales will not always be optimal. Often they will reverse the very moment your stop is triggered. That is the nature of the game.
The thing that is important is discipline. Draw a line in the sand when a trade goes bad and stick to it. You may not always like the results, but it is surprising how often a disciplined sale pays off. We tend to focus more on the bad sales than the good ones, but if you look back at some old trades you often will be surprised at how disciplined selling worked out.
Buying is much more fun than selling, but selling is what will keep our accounts near all-time highs and allow us to produce superior returns. Don't avoid thinking about selling. It is a trader's most powerful strategic tool.