Some of my stocks aren't doing so well today, and that got me thinking...
We have heard before that a decision to hold a stock on any given day is the same as a decision to buy at the current price. I think that you can take that statement too literally and forget both the frictional costs of investing and the opportunity cost of selling.
Two questions surround the decision to hold, and you need to answer both, not just one before you decide to change your position:
- Would I be comfortable buying the stock at this price?
- Would I be comfortable selling the stock at this price?
Holding a stock is not the same as buying, nor is selling the same as not buying. Buying increases your risk and your potential reward. Selling decreases your risk, but eliminates your potential reward. Holding maintains the status quo, balancing the current risk with the potential reward.
Holding should be a reasoned decision, not a state of crossing your fingers and hoping, but it still requires a balancing of the risk and the potential reward of your current situation. It should balance the feelings of greed and fear in your stomach with the knowledge in your head about this company that you have come to know.
It's easy to focus on the risk side of the equation, which I think is exactly what the "hold=buy" thought process does. The logic, as far as I can see goes like this, "If I wouldn't be willing to increase my risk with this company today, then why should I take any risks with them?" If the answer to question 1 is "No," then get out before everyone else does. This misses out on the potential rewards and leads people to sell too soon.
Question 2 presents the reward side of the equation, and could be rephrased as, "If this stock goes up 10% next week, am I going to kick myself repeatedly because I should have known it was going to happen?" This is the opportunity cost of selling, and it shouldn't be ignored by lumping holding in with buying. It also addresses the intellectual investment that you make in a company, which you essentially sell along with your stock when you decide to move on to a new investment. Sure, you can take lessons learned with you, and you may be prepared to "jump back in" down the road. For practical purposes, though, even as you increase your cash balance when you sell a stock, you reset our knowledge balance to zero when you move on to the next big thing.
Before I sell a stock, I make sure that I can firmly answer "No" to question 1 and "Yes" to question 2. If I'm wishy-washy in either answer, I hold until I can find something to make up my mind.There's a reason that a body in motion tends to stay in motion: energy was invested in that motion, and more energy will be required to change its direction. So, too, a decision to hold preserves the energy that has been spent on a stock, and a decision to sell expends it.
Sometimes, inertia is a good thing.
File under: Investing