Most traders and investors spend the majority of their time and efforts on finding stocks to buy. They are constantly looking for new ideas and attractive entry points. The logic is straightforward. If I find a good stock, then I just need to buy and hold on, and the rest will take care of itself.
Exits are generally an afterthought and can be very impulsive rather than the product of extensive research and a clear strategy. In many situations, the sell decision isn't even considered until a shift in market conditions or some sort of surprise news forces a decision.
It isn't just small investors that neglect exit points. In a 2019 academic study, researchers looked at 2 million sales, and 2.4 million buys made by institutional portfolio managers between 2000 and 2016. These managers produced positive results from their buying decisions, but when it came to selling, the stock that they sold outperformed those that they held. The study concluded that if these professional money managers had simply sold stocks at random, their selling results would have improved.
Why Exit Points Are Neglected
That is a stunning conclusion and illustrates how exit points and selling, in general, are neglected. There are several likely reasons for this phenomenon.
Buying tends to be forward-looking. The decision-making is thoughtful and carefully considered. Investors spend a tremendous amount of time studying fundamentals, charts, market conditions, and other factors that impact the buy decision. This is where time and resources are focused. The financial media is far more focused on discussions about which stocks to buy rather than to sell. The entirety of Wall Street is heavily skewed toward buy decisions rather than sell decisions.
Selling, on the other hand, tends to be impulsive and backward looking. It is quite often a reaction to changing conditions, and that makes it subject to behavioral and emotional biases, which leads to a suboptimal decision. Many investors never really spend any time thinking about how they may exit a stock if they are forced to. Many embrace the Warren Buffett dicta that his favorite holding period is forever. Why even bother thinking about exits when you only buy great stocks that you will never sell?
Exit points are neglected and tend to be worse than random, primarily because there is no plan. There is a tendency to sell the best-performing stocks and hold to the poorest when it is necessary to raise cash, which is typically the wrong thing to do.
The obvious solution to this problem is to make sure that there is some consideration of exit points when entering stocks. There are so many different potential outcomes to an investment or trade that it can be an overwhelming task to consider all the potential strategies.
For many investors, the best way to sell is to have a highly mechanical system that removes subjectivity. Rigid stop-out points can be your best friend, but they require strict discipline. As I've discussed in the past, a stop-out system that is combined with a rebuy methodology will help to alleviate some of the concerns about selling a great stock at the wrong time.
Like many other things in investing and trading, the solution to this issue is mindfulness. Simply being much more aware of how important it is to consider the sell decision in advance is far more effective than only acting when you are forced to. If we planned our selling decisions as carefully as we planned our buying decisions, then our returns would be substantially better.