There are several common investment mistakes around. The ones that get too much attention are buying shares whose price declines or when you miss investing in a company whose shares then rise. Think of people who passed good companies like Shopify and Amazon.
Another mistake that rarely gets any attention is to sell a stock that then keeps rising. In this article, we will look at some of the common reasons people sell stocks prematurely and how to avoid doing that.
The perils of selling stocks prematurely
One of my biggest regrets in my investing and trading career has been avoiding some companies whose shares keep rising. There are many. Some of the companies I missed were technology firms like Roku, Shopify, and Nvidia.
All along, my argument was that these companies were relatively overvalued and that they were facing strong competition. However, as shown below, these shares have had a parabolic rally in the past few years.
Nvidia, Shopify, and Roku
At the same time, I have watched in horror as some of the shares that I sold keep rising. Some of those stocks that I had stakes in and sold prematurely were companies like Target, Apple, and Tesla.
I am not alone. In 2018, Miles Johnson wrote an article in the Financial Times, in which he talked about the unspoken sin of selling shares too soon. He gave the example of a fund manager who bought good stocks during the 2008/9 financial meltdown and sold them a few years later. While his fund remained profitable, he missed the rally that lasted until 2020, when the pandemic started.
Why investors sell prematurely
There are several reasons why good investors sell their shares too early. Let us look at some.
Take-profit is triggered
A common reason why investors sell their shares prematurely is when a take-profit is triggered. For starters, a take-profit is a tool provided by many brokers that automatically stops a trade or investment when a target level is reached.
For example, if you bought a stock at $10, you could place the take-profit at $13 and range-bound stop-loss at $8. In this case, the investment will be stopped immediately when the shares rise to $13 or when they fall to $8.
Many investors sell their shares prematurely when market volatility increases or when a stock that has done relatively well starts to decline. In this case, they sell their shares as they fear a prolonged period of weakness of the shares.
For example, as shown below, in 2021, the Nasdaq 100 index declined by 12% between February and March and by 7% between early May and late May.
Nasdaq 100 declined in 2021
In these periods, it is possible for fearful investors to start exiting their positions.
At times, investors will sell these shares prematurely because they have gotten overvalued. This is an issue that is most common among value investors who are usually concerned about a company’s valuation.
At times, they will buy shares they believe are undervalued and then exit when they suspect that the shares have become significantly overvalued.
An investor can sell shares prematurely when they feel that the stock is not going anywhere. For example, you buy a stock that is trading at $10 and it remains range bound for months at a time when the S&P 500 has gained substantially. In this case, you may decide to exit your investment with the goal of finding another one.
How to avoid premature share sales
This is a common problem that is relatively difficult to avoid. Indeed, a look at history shows that many respected investors have sold their shares prematurely.
For example, a few years ago, Bill Ackman lost more than $4 billion when his investment in Valeant Pharmaceuticals went sour. He exited his investment when the shares declined to $10. At the time of writing, the stock is trading at $30.
Warren Buffett, too, has made the same mistake. In the 1960s, he bought and sold shares of Walt Disney when it was valued at more than $4 million. At the time, he owned a 5% stake in the company. Today, Disney is valued at more than $300 billion, meaning that his investment would be worth more than $15 billion.
Fortunately, there are several strategies that you can use to prevent making a mistake. Some of these are below.
Have an entry and exit strategy
To be clear, at times, selling a stock can make sense. For example, investors who sold their GoPro stock near $100 avoided major losses as the stock declined to less than $5.
Therefore, we recommend that you always have an entry and exit strategy when buying a stock. This means that you should have a good entry point and a good place to exit the shares.
As mentioned above, one reason why people sell shares prematurely is that they are guided by emotions. This is when they rush to exit their shares when the prices drop. This is wrong, especially when you are convinced that the stock is a good investment.
For example, in 2021, Cathy Wood of Ark Investment decided to buy more shares of growth stocks when the shares declined. This means that she was convinced that the shares will keep rising.
Have a long-term view
As a long-term investor, you should always have a long-term view of issues. As such, you should only buy shares that you believe will be highly valuable in the next few years. As such, at times, some declines will be good places to add more into your stake.
There are many mistakes you will make as an investor. We all make them. Prematurely selling shares is one of the toughest mistakes you can ever make. We have looked at some of the reasons why investors sell their shares early and some of the top ways to avoid the mistake.