The First Thing I Do After Buying A Stock

The first thing that i do after buying a stock is to forget the buying price. It is almost impossible to forget anything, intentionally. At least, i would try not to care, as the buying price is not only irrelevant to my trading decisions going forward, but also deceptive.

No one is perfect
Naturally, right or wrong, i tend to regard the buying price as a benchmark to measure the success of that particular purchase. When the market price of the stock goes higher than my entry price, i feel happy, or at least comfortable. Otherwise, i regret not having purchased that stock at lower prices, now available. i know i am not alone in having such feelings.

When the stock is trading at a loss, i tend to hold it and wish it a recovery, one day. By doing that, i am taking the risk that the stock will go further down and i will suffer from an even bigger loss. But my heart turns into a stone. Selling the losing stock, which is to admit the "mistake", seems to be the most embarrassing way to go. Investment psychologists call this behavior "fear of regret". Elton John sings: "Sorry seems to be the hardest word."

Emotionally, i tend to hold a loss-maker longer than i ought to, while i am often tempted to sell a winner much sooner than i should. The psychologists said the urge to take "pride" makes an investor sell a winner earlier than necessary. i think of other reasons for reckless profit-taking. Many people would rather spend the windfall, the "house money", on some nice vacations, plasma TVs, or new computers. By selling a stock, i bear the risks that the stock will rise further, and i miss the opportunity to make an even bigger profit.

Don't be a prisoner of the past
The truth is whether you should hold, sell, or even buy more has nothing to do with the entry price. Economists regard the entry price as a sunk cost -- one cannot turn back the clock. Investors should be forward-looking. Who on earth should be a prisoner of the past?

The best strategy

Expected price movement from now on     Current status      Best move
Up                                         Profit          Buy/Hold
Up                                          Loss           Buy/Hold
Down                                       Profit            Sell
Down                                        Loss             Sell

The table above is simple and clear. Whether i am making a paper profit or loss, i should hold the stock, or even buy more, if i expect the share price to go up from now. i should sell the stock, may it be presently a winner or loser, if i expect it to go down.

Back to square one, the question is always where the stock will go. Value investors look into future earnings and/or cash flows. Technical investors watch charts. Even though chartists may be looking backward (on past trading records), they do not necessarily base their decisions on their personal buying prices. Rather, they use the past trading pattern of the market to predict the future price movement.

Profiting from others' weakness?
Could we exploit the opportunities that arise from other people's weakness?

The market behavior, as collective behavior of individual investors, is too complicated to analyze by the means of "fears of regret" and "seeking pride". Trade happens when there are equal numbers of shares being sold and bought at a certain price. Both buyers and sellers exist at the same time and insert forces in different directions. However, to a certain extent, psychology contributes to the analyses of support and resistance levels of share prices.

Cut loss?
Some argue that investors should not only deny "fears of regret" and "seeking pride" emotions, but also go to the other extremes. That's to sell quickly when the stock falls below the entry price, and hold onto the stock that rises well above it. They point out that risk tolerance varies with wealth. When a stock falls, the loss would erode the core saving, on which the investor depends for his living or retirement. He should cut his losses. In contrast, when a stock rises well beyond the entry price, the investor's basic needs become less of a concern, and therefore he may go ahead and take higher risks, by holding onto the star performer.

That sounds reasonable, only when putting it into the perspective of the whole portfolio, but not a single purchase.

Value -- the benchmark
i believe a stock has a value. The lower the market price, the bigger is the discount to that value. That makes the stock a safer investment. The higher the market price, the bigger is the premium to the value. That makes the stock a shakier investment. That doesn't necessarily mean that i would blindly hold onto losers. Should the business environment change, or fundamentals deteriorate so severely that the value of the stock falls below the market price, i would sell the stock, even at a loss.

Feb 23, 2005
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