In the internet age, there is no shortage of information out there about which ASX shares to buy.
However, there is a dearth of advice on when to sell.
Fairmont Equities managing director Michael Gable argues that this is absurd.
"I would go as far as to say that the split in terms of importance is not 50-50," he told SwitzerDaily.
"I would say the most important skill is knowing when to sell."
An investor can pick the most brilliant winners to buy but that all comes to nothing if they sell out of it too early or if they have another stock that's plunged to zero.
"I have heard plenty of stories where clients picked Afterpay or CSL Limited (ASX: CSL) very early on but took a quick profit instead of achieving life-changing profits," said Gable.
"Yet these same people often have a couple of stocks in the portfolio that have shed most of their value."
The issue with holding onto losers, hoping they would come back to break-even, is that it will ensure your portfolio bleeds money.
"If we are happy to take profits at 5% or 10% but hold onto a 'good business' if it falls 20% to 40%, then you will never make progress," said Gable.
"I see this strategy too often, and it is a losing strategy."
And don't forget, the bigger the losses, the harder it is to recover the deficit.
Selling an ASX share that's lost you 10% means you only need to buy a replacement investment that nabs 11% to make that money back. But not selling until a stock has lost 50% means the next investment needs to double!
It's human nature to hold onto losers — but it makes no rational sense, according to Gable.
"My experience with investors is that the more a stock loses, the more reluctant they are to sell it. I hear things like 'keep it in the bottom drawer', or 'it's too late now', and 'I'm happy to hold it long term' to justify what has been a bad investment," he said.
"And we all make bad investments, by the way. It is part of the territory."
Image source: Getty Images
Share prices don't correlate perfectly to company's earnings
The trouble is, stock prices don't move just according to company performance.
Emotions, or what finance professionals euphemistically call "sentiment", have an impact. So do factors outside of the business' control, like interest rates, government handouts and quantitative easing.
Gable said once an investor realises the market is not efficient but unpredictable, you stop having "conviction" about a stock but shift to a risk management mindset.
"You can spend your whole life trying to understand the market to only come to the conclusion that you still know nothing," he said.
"When you realise this, you start to think in terms of probabilities, not absolutes."
To demonstrate how bad even the professional analysts are at judging the fortunes of an ASX share, Gable took Appen Ltd (ASX: APX) as an example.
In August 2020, after its half-yearly results, Appen shares fell 20% in one day. Analysts were climbing over themselves to tell investors this was a golden buying opportunity.
A year later, the stock fell a further 70%. Analyst target prices had also fallen by then, but they were still above the price at the time, indicating they still thought it was a buy.
"If the experts on the business get it wrong in such a spectacular fashion, then what chance does the average person have?" said Gable.
"We all get some wrong. It is inevitable. But we have to accept this and stop the bleeding at some point so it doesn't hurt the rest of our portfolio. This is why risk management is important."
So how and when do we sell a losing stock?
Without a firm selling strategy, retail investors won't act fast enough to stem the bleeding.
"By the time something has changed and the average person on the street becomes aware of it, the stock price has already been destroyed," said Gable.
"The average investor can benefit from having a strategy in selling stocks that goes beyond waiting for an analyst to tell them that the 'fundamentals' have changed."
Gable suggested a couple of selling strategies that retail investors can easily follow.
The first is to see how the share price moves in reaction to good news.
According to Gable, if the share price can't rally upwards after positive news about the business, it is "a classic sell signal".
"You may have been too shell-shocked to sell Appen when it dropped 20% in one day," he said.
"But if all the analysts release their reports in the next few days saying how wonderful the business is and are encouraging their clients to buy it, but the share price cannot recover, then that is a massive 'tell' on what is really going to happen."
The moral of the story is that there is a major problem if the share price doesn't do what it "should" be doing, especially when the rest of the market is fine.
"If the stock cannot rally on good news, then it is only going to go backwards. This is therefore a sell signal."
The second strategy is to set a trailing stop.
This is to sell a stock when it falls beyond a certain amount from the current price.
"We only want to hold stocks that are in an uptrend. When this uptrend is over, it is time to sell. We are not concerned if the uptrend lasts 10 days or 10 years. We also don't care if a stock is cheap or expensive," said Gable.
"If it is going up, it is making you money. When it is going down, you are losing money."
If a stock is doing well, this exit point will move up with the current price, ensuring you don't cut a winner. But if the sentiment turns, then the trailing stop can "catch" you.
"Having some rules like this is one way to help those who are time-poor and/or not professional investors manage downside risk."
