To improve your trading and investments, spend more time on exit points

Most traders and investors spend the majority of their time and effort finding stocks to buy. They are constantly on the lookout for new ideas and attractive entry points. The logic is simple. If I find good stock, then I just need to buy and hold, and the rest will take care of itself.

Exits are usually an afterthought and can be very impulsive rather than the product of thorough research and a clear strategy. In many situations, the sell decision is not even considered until a change in market conditions or some sort of new surprise forces a decision.

It’s not just small investors who overlook exit points. In a 2019 academic study, researchers looked at 2 million sales and 2.4 million purchases made by institutional money managers between 2000 and 2016. These managers produced positive results from their buying decisions , but when it came to selling, the stocks they sold outperformed. those they held. The study concluded that if these professional fund managers had simply randomly sold stocks, their sales results would have improved.

Why exit points are overlooked

This is a stunning finding and illustrates how exit points and selling, in general, are overlooked. There are several probable reasons for this phenomenon.

Buying tends to be forward-looking. Decision making is thoughtful and well thought out. Investors spend a tremendous amount of time studying fundamentals, charts, market conditions, and other factors that affect the buying decision. This is where time and resources are concentrated. The financial media is much more focused on discussing which stocks to buy rather than sell. The entirety of Wall Street is heavily geared towards buy decisions rather than sell decisions.

Selling, on the other hand, tends to be impulsive and retrospective. It is quite often a reaction to changing conditions, which makes it prone to behavioral and emotional biases, which leads to a suboptimal decision. Many investors never really spend time thinking about how they might get out of a stock if forced to. Many embrace Warren Buffett’s saying that his favorite holding period is forever. Why even bother thinking about exits when you’re only buying good stocks that you’ll never sell?

Exit points are sloppy and tend to be worse than random, mostly because there’s no blueprint. There is a tendency to sell the best performing stocks and hold onto the poorest ones when it is necessary to raise funds, which is usually the wrong thing to do.

The solution

The obvious solution to this problem is to ensure that there is some consideration of exit points when entering actions. There are so many different potential outcomes for an investment or trade that it can be an overwhelming task to consider all of the potential strategies.

For many investors, the best way to sell is to have a highly mechanical system that eliminates subjectivity. Rigid breakpoints can be your best friend, but they require strict discipline. As I have explained in the past, a stop-out system combined with a rebuy methodology will help alleviate some of the worries about selling a big stock at the wrong time.

Like many other things in investing and trading, the solution to this problem is mindfulness. Simply being much more aware of the importance of considering the selling decision in advance is much more effective than acting only when you have to. If we plan our sell decisions as carefully as we plan our buy decisions, our returns would be significantly better.

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