The Importance of Having a Sell Strategy

ExitToday, I’d like to share with you the story of both my greatest investing success and my greatest investing mistake. Unfortunately, you’re about to find out that both stories relate to the same investment.

It was the latter half of 1999. Tech stock mania was running wild and stocks were delivering unprecedented returns. Since every tech stock was going through the roof, I ended up buying a few and one of them was Internet Capital Group. They were basically a venture capital business for technology start-ups. I hadn’t done any real research but it sounded good to me. After all, every tech stock in the world was going up.

I bought moments after an analyst upgrade was announced and got in at about $117 a share. By the end of the day, it was over $140. Within a month, it was over $200. I couldn’t help but think about how easy this was. I reasoned that if the stock had done this well in such a short period of time it certainly could keep going for a while longer. At this point, everything was working out great except for one small fact – the tech bubble was about to burst.

Within a few months, the stock had entirely retraced its steps and it was back to the point that I bought in at. Regret was starting to set in and I was desperate to get my winner back. So I held on.

But the downturn continued. The same tech stocks that were all the rage just months earlier were now radioactive and the stock that I had done so well on so quickly was becoming a loser. A big loser. I rode it down and down for another couple of months until I had finally reached my personal point of surrender and sold. The final selling price? About $40.

Too often, people consider the concept of “sound” investing as picking the right investment and buying in at the right price. In truth, that’s only half the equation. When to get in can be just as important as its counterpart – when to get out.

As you can see, I was spot on when it came to picking a stock and getting in at the right time. My fatal flaw was two-fold: Not doing proper research on what I was investing in and not establishing a target price at which I would lock in my gain.

When I bought Internet Capital Group, all I really knew about it was that it was a tech stock. Since virtually every stock in the sector seemed to rise on a daily basis, I figured that alone made it a good investment. Although things like P/E ratios didn’t seem to matter much at the time, even a rudimentary analysis would have pointed out that the stock was vastly overvalued and the viability of the companies that it had stakes in was, at best, frail. Simply put, even though it worked out nicely at first, it was a bad investment from the start.

The real importance of doing your research before investing is in establishing a true value of the investment. That’s what determines whether it really is a good investment or not. The analyst upgrade that prompted my initial decision to buy said that the stock was valued at $200. It hit that price in a matter of weeks. Would that have been a reasonable price target for me since in fact I had no idea how much the stock was actually worth? Probably.

Setting a price target and sticking to it helps take the emotion out of investing. Had I set a $200 price target and sold once it hit that point, I should be absolutely satisfied with locking in my gain even if the stock proceeds higher still (the idea of “behavioral finance” argues that investing decisions like this should be absent of emotion but in reality we know that’s not often the case).

I like to think that I’m a better stock trader today than I was back then. The one thing I do in every case I buy a stock now is set a price target. Every case. I’ve had one case where I’ve gotten out near the top (a financial services ETF I bought recently) and I’ve had two cases where I sold at my price target and the investment has continued much higher. It still hurts a bit to think “what if” had I held on a little longer but the fact is that in each case I still sold with a sizeable gain.

And nowadays, that’s good enough for me.

Photo credit: alvaroprb

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Author Info

This post was written by David Dierking. David lives outside Milwaukee, Wisconsin and has been working in the financial services industry for over 13 years with a background in investments, accounting, and marketing. He earned his Chartered Financial Analyst designation from the CFA Institute in 2004 and was recently published in the Milwaukee Business Journal. You can also check him out at The Ultimate Fit Challenge

4 Responses to “The Importance of Having a Sell Strategy”

  1. Edwin |  Dec 08, 2009 at 5:09 pm

    Arguably even more important than having a sell strategy is having a basic grasp of financials and the economy (as you mentioned here) allows you to properly investigate companies you are investing in to see how stable the investments really are.

    But then again, that takes not only a bit of education in the area, but also time to look over the filings of every single stock and possibly even attend their investor meetings (online of course). Maybe a better strategy is, as you said, to just set a sell price and try to avoid the emotions that get us into bubbles at the wrong time.

  2. David |  Dec 08, 2009 at 5:38 pm

    True.

    My original thought when writing the article is that I wanted to convey why it should be important to develop an exit strategy for when you feel a stock has become fully valued. As I mentioned, I couldn’t discuss why I lost on this investment without touching on the fact that I really didn’t know a thing about what I was investing in in the first place so I discussed both points.

    I agree with you though on your points.

  3. Sun |  Dec 13, 2009 at 1:17 pm

    Figuring out when to sell is always harder than deciding when to buy. When the price went up, there’s always the temptation of profiting from an even higher price. When the price went down so much, the fear of realizing the loss sometimes is just to overwhelming. An exiting plan should be in place before a trade is made.