I often write about how it is better to react to market conditions rather than try to anticipate what will happen. This article from Friday morning is a good example of this theory.
Like many theories about the stock market, it is much easier to state than to put into actual practice. What if you stay patient during an uptrend but react too quickly to the first signs of weakness? What do you do if you are shaken out of good positions due to a short-term bout of volatility?
For a while now, one of the easiest mistakes to make in this market has been to overact to weakness. There is one bad day in the indices and prudent traders rush to play defense and protect their capital. That is the smart move in many cases, but it is still quite frustrating when the market bounces right back up.
The key to dealing with this problem is to change the way you think about selling. Selling a stock shouldn't be viewed as some finite decision. Many people have an aversion to rebuying a stock they sold, because it is an admission that we were wrong to sell it in the first place. If you don't like to admit to making mistakes, it can make trading much more difficult.
I find it helpful to think of selling as just a form of insurance. We can rebuy a stock at any time for any reason. If we pay a higher price than what we sold it for, that is simply an insurance premium. We reduced our risk for a period of time -- and we paid a price to do so. That is exactly what happens when we buy insurance of any type. We pay a price in order to transfer the risk of a substantial loss to someone else.
When you think of selling as nothing more than insurance, you tend to look at the way you handle your stocks quite differently. Even if you are convinced you are holding a great stock, there may be times when the risk to the downside is large enough for you to take out insurance -- by selling.
The key to viewing selling as just a form of insurance is the willingness to rebuy a position you have already sold. You have to forgot history and view the position with fresh eyes. The fact that you sold it at a higher or lower price is irrelevant. The only thing that matters is whether it is a favorable buy at this point.
What is particularly important is that you be willing to buy at higher prices. That can be a major mental obstacle for many people. They simply can't overcome the fact that they owned it at a lower price and now have to pay more. If you think in terms of "value," it can make it even harder to pay up for a stock that you already sold.
I've used this idea of selling as insurance to great benefit in trading stocks like Acacia Communications (ACIA) . Although I continue to hold a small core position, I have sold and rebought a number of times. And a number of times I paid $30, or more, for shares that I had just sold a few days previously -- and ended up doing quite well.
Rethink the way you consider selling. It is simply a strategic tool to use to reduce risk at various times.