Should I sell ?

I have been receiving this question and its variants via comments and emails for the last few days.

Let me try to answer this question from my point of view. My response may not be typical of what is usually recommended and may not suit your specific case.

I am wary of a simplistic approach of selling stocks at an X % profit or at predefined index or price level. A decision to sell, like buying is more nuanced and requires more thought than that.

Two criterias for selling
In my case, the selling criteria is part and parcel of the analysis done before buying the stock. I typically will have an exit criteria in mind based on fundamentals and valuation at the time of buying the stock. If the business fundamentals deteriorate more than expected (see my post on India nippon), then I will sell the stock if I think that the drop is not temporary and the intrinsic value will stagnate or drop in the future.

The second case where i sell the stock is when the current price exceeds the intrinsic value by 10-15% and the future increases in the intrinsic value is less than the returns I can get via other opportunities. So if the stock is selling at intrinsic value and I can find another idea at a 40% or higher discount, then I will sell the stock and re-invest the proceeds in the new idea.

You will notice a lack of reference to any pre-determined index levels or fixed increase in stock price in my sell criteria. For starters, index levels do not have a direct bearing on individual stock. My pick can stagnate when the index is rising and vice versa. So selling a stock just because the index has gone up would be foolish

Mental accounting
I will also not sell stock just because it has gone up by X% to ‘book’ some profit and leave my profits behind. This would be a clear case of mental accounting (put cost and profit in different mental accounts) and an attempt to avoid regret. If one breaks the investment into different mental accounts, there is tendency to recover the cost and let the profit run. I see no reason to treat profits any different from the cost. The entire money is just one single account (available capital) and it is important to take decision on the entire holding as such.

Avoiding regret
A common reason for selling is also to avoid regret. If the market drops, I will regret losing the profit. However I would say that in the short term, it is impossible to avoid regret. If the market rises, then you will end up regretting selling the stock and losing on the upside.

If I cannot predict the markets and avoid regret, the best option is to have an approach based on intrinsic value and accept the fact that I could face regret in the short term irrespective of my decision. The same scenario occurred for anyone who waited for the election results to commence buying. In order to avoid the regret of buying at a higher price and then see the price drop after the elections, they ended up watching the price shoot up and are now regretting missing the rise.

Final bias – hindsight bias
The silliest reason by far is to evaluate a decision based on how the market moves in the short term. If the market rises after I decide to hold the stock, does it make me smart or stupid if the market drops? absolutely not !!

All investing decisions have to be taken based on current information and in absence of knowing which way the market will move, my decision can appear to be very smart or stupid in the short run. However if you follow a rational approach of buying and selling stocks based on some measure of value, then short term market movements should not trouble you too much (which ofcourse is easier said than done)