- (1) A stock begins to show decaying fundamentals, such as lower profit margins or lower return on invested capital,
And the market is always very unforgiving to the investor holding on to such stocks.
And sometimes it could wipe the investor out of the game.
Having said that, knowing what needs to be done and actually doing it is rather difficult.
All of us have different emotions and for many emotions is a deadly hindrance in the stock market for it prevents the investor of doing what needs to be done, which is acknowledging and rectifying the mistake(s) made in the investment(s).
The following passage is taken from the following book, Investor Therapy by Richard Geist.
- “Behavioral problems with selling can often be traced to difficulties, conscious or unconscious, in handling the emotions of loss. Loss is associated with selling a stock in a variety of ways, not all of them purely financial. If a stock retreats below its buy price, investors become concerned not only with taking a loss, but also with how much of a loss is reasonable to bear and when to bailout and accept the loss. To one degree or another, the loss at issue involves more than money. At least as important are loss of time, loss of self-esteem, and loss of validation by others. Similar emotions of loss can also play a role when a stock has appreciated, since letting go evokes fears of foregoing future upside potential in the stock being sold, as well as lost opportunities elsewhere in the market if the stock isn't sold. More subtly, and sometimes unconsciously, investors become concerned with loss of their connection to a company they know well. This can also involve fear of losing a close working relationship with admired members of the company's management. Sometimes we also have difficulty letting go of a stock that we experience as an important possession. Stock ownership can provide a valuable attachment, and such a sense of belonging can be difficult to relinquish.
Many investors will deny that the idea of emotional loss enters into their investment decisions. As one investor commented, "I don't have to deal with emotions because I use a computer system that tells me when to sell." In other words, a system obviates the need for emotional involvement. However, my qualitative research into investment errors in both amateur and professional investors suggests otherwise. In fact the strength of these denials seems generally proportional to an investor's resistance to introspection. It betrays the fear that a glance inward at our psychological reactions will destroy our capacity to concentrate on the external reality of everyday buy and sell decisions. While all systems are designed to eliminate emotions from buy and sell decisions, if strong enough, those emotions can overrule any system at just the wrong moment.
LOSS SYNDROMES THAT INTERFERE WITH SELLING DECISIONS
The specific ways our feelings about loss impact investment decision-making, particularly selling, have not been well studied. We do know, however, that all adults were once children and that we cannot grow up without experiencing either emotional or real losses on many levels. In general the fewer losses we experience, and the more help we get in dealing with those that do occur, the stronger our sense of self in adulthood. Feelings of loss, when unrecognized, have the potential to seriously interfere with the selling process, as the following examples illustrate.
Separation Anxiety. One very intelligent investor who consulted me about his difficulty selling stocks realized he frequently lost profits because, as he stated, "I know intellectually when to sell, but I just can't seem to let go of the stocks when I should." Carl provided numerous examples dating back several years of how he failed to sell his holdings in a timely fashion, each time ending his example with "I just could not seem to let go." I finally told him that I was struck by his repetitive use of those words-could not seem to let go-and wondered if they had some unusual importance in his life. He smiled and told me he hadn't remembered this in a long time, but when he was young he had difficulty leaving his mother when going to school. Other kids used to tease him about "not being able to let go of her." And "teachers used to tell me that I had to let go of her. I always thought something terrible would happen if we were apart." Carl's "separation anxiety," to use the psychological jargon, hadn't been particularly severe and hadn't lasted very long. But as Carl realized that day, his feeling that something terrible would happen if he "let go" was influencing his behavior in the stock market.
The obvious question from this example is whether Carl's insight into his "separation anxiety" would cure his inability to sell when he knew the time was right. While intellectual insight rarely cures all ills, the investor in this case was able to make more timely sell decisions. His recognition of an important organizing lens-letting go leads to disaster-didn't remove it. He still felt anxious when he sold stock. Yet at least he could say to himself, "I know I'm feeling anxious, but that anxiety belongs to a time in my childhood that is unrelated to current market realities. Letting go here actually leads to protecting myself." This was a happy ending, since it involved an expansion of his organizing lenses or emotional convictions, and it turned out to be one of the keys to his future investing success.
Unresolved Losses. Investors who have grown up experiencing unresolved losses often have specific difficulties in selling their stocks. Where feelings of loss are still raw and exposed, the idea of losing money in the stock market can be intolerable. Any potential loss in the market telescopes all former nonmonetary losses into the present. As a result, these investors are likely to sell too early. Their decisions are not based on the fundamentals of their investment but on the need to avoid rekindling the emotion of loss. As one investor said, "I just can't tolerate the feeling of loss. It has nothing to do with my stock; I just sell before a price drop gets too big so I don't have to confront the feeling." Arbitrary rules to sell when your stock retreats 7 percent or 8 percent below your buy price may prove to be the right choice in some cases or exactly the wrong choice in others. Either way it often reflects a technical rationalization of an emotional need to avoid feelings of loss and disappointment at any cost.
On the other hand, emotional conflicts from unresolved losses can also steer investors in the opposite direction. Where the conflict is from the denial of painful losses, an investor is more likely to hold on to a losing position well beyond the time indicated by the fundamentals. These are the investors who are likely to say, "It isn't a loss until I've actually sold my position, so I think I'll just hold on for a while longer." In other words, as long as we can deny that our loss is real until we sell, we tend to hold on to our losers while selling our winners, just the wrong strategy for success in the market. Selling the winners too early convinces us that we are not playing a loser's game, while reinforcing our denial that keeping our losers avoids a real loss.
The effects of this type of unresolved loss on investing decisions are most dramatic on the anniversaries of the emotional losses, even if they occurred many years earlier. These anniversaries can be represented symbolically when they become associated with particular seasons, holidays, or months. Many investors do best not making important investment decisions during those anniversary periods.”
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