Selling is the most powerful tool in trading, but its effectiveness depends on how you use it in conjunction with a rebuy strategy. The failure to re-enter a good stock after a sale is the biggest drawback to active trading and investing. Once someone is on the sidelines, it can be tremendously difficult to jump back in. Inertia sets in, and there is a tendency to think that it is too late to act.
In a recent article, Barry Ritzholz cites a statistic from an academic study: "We find that 30.9% of the investors who panic sell never return to reinvest in risky assets."
Panic selling was defined as the liquidation of 90% or more of an account. Not all liquidations are due to panic, but the point is that a large number of folks who move into cash never return. This is a worry for money managers who lose assets under management, but it shows how individual investors fail to appreciate the cyclical nature of the market and the great likelihood that they will be able to recoup losses if they persevere.
The bias against rebuying a stock that has been sold is one of the primary reasons that buy-and-hold investing is often viewed as a superior approach. It keeps investors in the market and eventually, over time, they are likely to do well and recoup even substantial losses as the market cycle turns.
A trading or investing system that automatically sells and rebuys a stock will not only outperform buy-and-hold investing but will do so with reduced risk.
Like so many things in trading and investment, you must have the discipline to employ a plan and follow it. If you aren't, then you might as well be a buy-and-hold investor and just hope that your stock selection is good.
The hardest thing about the rebuy strategy is that it requires a shift in thinking. Too often, market players feel that once they sell a stock then the relationship has ended, and they no longer can touch that stock. They just move on and hope to find something better. There isn't any particular reason why you can't return to a great stock that may have treated you poorly at some point. It may well be the best idea you can find, so why not stick with it and try again?
Once you start to embrace rebuy thinking, then the selling decision changes its complexion. It is no longer a big deal. It is just a strategic move that puts you in a position to make a timely rebuy.
One of the most important elements of the rebuy is to forget your prior entry and exit points. They are not relevant. You have to think of the rebuy on its own merits. Whether you are paying higher or lower than what you have sold the stock for doesn't matter. All that matters is whether the new entry point is attractive or not.
The great value of the sell and rebuy is that it helps to reduce the risk that you are holding the wrong stocks for the very long term. If you sell a stock and then it never sets up again for a rebuy, then you will free up that capital and be able to find a good alternative.
The sell and rebuy strategy will beat buy and hold, but there is a huge danger that you will not execute. If you don't have a clear plan and are not disciplined, then a superior strategy like sell and rebuy is suboptimal.