Have you found yourself poring over your investments, wondering whether now is the right time to make a change? Or are you regretting selling an investment after panicking – only to have the stock subsequently correct shortly after what was ultimately minor drop?
You're not alone – emotions disrupt investor behavior – especially in this market. But there is a solution, and it's called a sell discipline.
A sell discipline is a strategy that an investor has in place before ever purchasing an investment. The investor has done his or her homework and comes to a conclusion about what a particular stock is worth, and more importantly, at what value to sell out of the position if it moves negatively. By having these numbers in mind before buying, you have already made the objective decision of when to sell the security. It's all about having a game plan in place.
Because markets are volatile, a sell discipline helps decrease the emotional aspect of investing, which often results in investors buying when they feel good about the markets and selling hastily when they're down.
Still not convinced a sell discipline is for you? Below we will outline three reasons why you should have a sell discipline.
1. You could be wrong
All the research in the world can't prepare you for a stock performing poorly. There have been so many stocks in history – look at Facebook – that seem like they have good future potential and end up disappointing. Just because it's a great company; or its management is fantastic; or the product has generated significant buzz, does not mean that the stock will perform well.
If the stock doesn't live up to your expectations, a sell discipline allows you to admit you're wrong, cut your losses and move on.
2. Even good long-term stocks have short-term volatility
In this market, consistency is an anomaly. Even long-term investments have volatility in the short term. A good example is the financial sector in recent years. If one company in the financial sector shows a weakness, it tends to hurt the entire sector.
If that happens to a stock you own, you want to be able to step to the side and not overreact immediately. You may even be able to buy the stock back at a later time, lower than where you exited it.
3. You can lock in profits
The first two reasons to employ a sell discipline outlined above had to do with minimizing downside risk. This reason has to do with making a profit on a stock.
If you have an upside discipline, you're going to be able to bank that profit without holding off and thinking the stock will go even higher. It's possible that if you hold on to a stock too long and don't sell it when it goes higher that you will ride the stock all the way until it bottoms out.
If you don't have the time or skill to master your sell discipline objectives, find a financial planner that can help you take control of your emotions. Some people are independently able to practice an effective sell discipline, while others need a financial professional as a guide.
Without an effective sell discipline, you're going to be flying blindly in the markets. And you're going to be at the mercy of the direction the markets are going, for better or for worse.