Stocks—It Is When You Sell That Matters

By Dennis Ng (guest contributor) In Singapore, there is no lack of investors who place their money in stocks. However, I observe that the majority of stock investors know very little about stock investing. To help clear the air on stock investing, let me share with you some common mistakes made by retail investors. Many investors make the mistake of buying stocks without knowing when to sell them. As important as it is to buy stocks that matter, knowing when to sell stocks is paramount in stock investing, as it can dictate whether one would reap profits or incur losses. When it comes to stock investing, some investors hold onto their stocks steadfastly. It is as though they have developed deep emotions with their stocks and are in ‘love’ with them. It sometimes appears to me that these investors hope to tide through the thick and thin with their stocks. In doing so, they fail to realize that they have just committed a cardinal sin in investing, which is getting emotional about investing. When we invest, it is imperative that we keep a clear mind and stay rational. When we invest, we have to avoid letting our emotions affect our decisions. That much said, it is a tall order to be completely void of emotions as we are emotional beings by nature. But as what billionaire investor Gorge Soros said, “It’s impossible for human beings to be emotionally detached when we invest, but the key is to learn how to control our emotions, to be as emotionally stable as possible, when making investment decisions.” Misconception 1—The decision to buy blue-chip stocks is a safe one Some investors erroneously believe that as long as they buy blue-chip stocks, they can be rest assured that their investments will be in good hands. But this belief is not entirely without flaws. So what are blue-chip stocks? Blue-chip stocks typically include the 30 component stocks that make up the Straits Times Industrial Index (STI), as well as some very large and established companies listed on the stock exchange. If you are to buy stocks when the stock market is near its peak—when stock prices are high—buying blue-chip stocks might end up giving you the ‘blues’ instead. For instance, imagine you had bought DBS shares in 2007, when they were trading at above S$20. If you had waited four years before selling your stock in September 2011, when the stock was priced at below S$12, or had fallen by 40%, you would still have suffered a painful loss of 40%. In your defense, you could justify your buy by saying that such blue-chip stocks pay you dividends. But even if the dividends handed out is at 5%, a 40% decline in share price means you technically need to collect eight years worth of dividends to recoup the loss incurred when you mistakenly bought stocks that were over-priced. Misconception 2—Stock prices always go up in the long run Investors who have made the mistake of buying overpriced stocks argue that even if stock prices fall in a bear market, its share price will eventually make a comeback as long as they have holding power. While this, in theory, is aligned to the teachings of investment textbooks that claim stock prices always go up in the long run, I beg to strongly differ. As much as I do not wish to dash your hopes, but investing based on hope is not quite a strategy. The reason is that the price you paid for your stock has no relevance to anyone except yourself. The stock market does not owe you an obligation to ensure you break even in your investments. If you have over-paid for the stock, the value of this said stock could still be much lower than your purchased price in the long run. For instance, back in 2000 when technology stocks were the rage, Creative Technology, which was trading at a high of S$55 at one point, was one of the STI component stocks and deemed one of the ‘market darlings’. But fast forward 11 years later, in September 2011, the same stock is valued below S$4, representing a staggering decline of 90%. Misconception 3—Paper losses are not real losses There are investors who simply refuse to face up to reality. They do not wish to admit that they might have made a wrong investment decision, or have made an incorrect analysis or wrongly judged a stock. Such is their extent of denial that they might claim to only have suffered some paper losses if you ask them how much loss have they incurred. So long as they do not sell their losing stocks, their losses are not deemed to be real, at least in their opinion. Now imagine a scenario where a Japanese investor bought some Japanese stocks in 1989, when the Nikkei stock index was as high as 38,915 points then. Today, even after a long 22 years, the Nikkei stock index is well below 9,000 points or about 76% lower. If the Japanese investor still insists that the loss is just paper loss and not real loss, it becomes very obvious that he or she is just in self denial. By now, you might be wondering why I am familiar with the common mistakes and misconceptions held by retail investors. Well, to be honest, I used to be guilty of committing such investment mistakes due to the misconceptions that I had. During the Asian Financial Crisis in 1998, when the STI index fell by 68% from a high of 2,500 points to 800 points, I told myself that everything would be alright. I told myself that so long as I have holding power, I would not lose my money. But that was of course, not the case. Through losing over 50% of my wealth in the stock market crash, I learned the truth about investing the hard way. It was then that I had a rude awakening as to how little I really knew about stock investing and that I had needed to learn how to make wise investments to have any hope of making money from stock investing again. That marked the turning point in my investing journey. There is a saying that “when the student is ready, the teacher will appear.” After suffering a hard fall, I met and learned a lot about investing from several multi-millionaires in Singapore. I also read many investments books, attended many such seminars and eventually picked up some practical and useful tips on stock investing. I then learned that the crux of investing is in knowing when to sell your stocks. So are you ready to learn when to sell your stocks? 1. Sell when the overall stock market trend changes No matter what stocks you buy—be it blue-chips, red chips (China companies listed in Singapore) or ‘potato chips’ (i.e. stocks without fundamentals)—when the overall stock market changes from an uptrend to a downtrend (bear market), or when the overall market direction reverses, it is time to sell all your stocks to avoid losing more money in a potential market crash. If you are to look back at past trading trends, you would realize that in a bear market, stock markets typically fall by over 50%. In Singapore, the STI fell from 2,500 points in 1996 to just 800 points in 1998, representing a 68% fall. In 2000, STI fell from 2,500 points to 1,200 points in March 2003, representing a 52% drop. And in 2007, STI fell 62% from 3,900 points to its lowest of 1,456 points in March 2009. That much said, how do we know that the direction of the overall stock market has changed? To do so, you might want to keep a close watch on the 200-day moving average. By doing so, you would be better informed whether the trend remains up or has tipped over to a downtrend. 2. Sell when stocks are over-priced How do we know whether a stock is over-priced or not? In answer to this, price earning (PE) ratio serves as an indicator to whether the price of a stock is reasonable or not. In which case, price earnings ratio is basically derived by dividing the stock price by its earnings per share. If the PE ratio is 20 times, it means that the company will take 20 years to obtain enough earnings to pay off your capital. Put simply, the return on investment is 1 divided by 20, or 5%. Thus, any stock trading at a PE ratio of 20 times or higher may suggest that the stock is over-priced, unless the company can grow at a much higher rate. Having said that, we need to understand that every industry is different. Instead of making our investment decisions based on PE ratio alone, we need to compare a company with its peers when coming to a conclusion as to whether a stock is over-priced or not. 3. Sell when we made an investment mistake Sometimes, it might take us awhile for us to discover that our initial analysis of a stock is incorrect. In which case, we might have over-estimated the company’s prospects and profits, or the company did not quite manage to execute their expansion plans as successfully as we had thought. Regardless of the investment mistake made on our part, we must not hesitate to admit our mistakes and sell those stocks immediately. In doing so, we are cutting our loss so as to refrain losing even more money if the stock price falls further. 4. Sell when a better investment opportunity arises If you have already fully invested your money but discovered at some point that another stock has better prospects or value, you might want to sell some of your existing stocks in order to raise capital to invest in the latter stock. In summary, successful investing has more to do with when you sell your stocks than when you bought them. The four approaches to selling stocks have served me very well over the years and helped me avert the ill fate of incurring losses during the stock market crash in 2008. It is my hope that these approaches would similarly serve your investment decisions well. .