Page 374 - How to Make Money in Stocks Trilogy

When You Must Sell and Cut Every Loss . . . without Exception 249

The psychology of normal investors is not much different. They hope
more turkeys will return to the box when they should fear that all the
turkeys could walk out and they’ll be left with nothing.

How the Typical Investor Thinks

If you’re a typical investor, you probably keep records of your transactions.
When you think about selling a stock, you probably look at your records to
see what price you paid for it. If you have a profit, you may sell, but if you
have a loss, you tend to wait. After all, you didn’t invest in the market to lose
money. However, what you should be doing is selling your worst-performing
stock first. Keep your flower patch free of weeds.
You may decide to sell your shares in Myriad Genetics, for example,
because it shows a nice profit, but you’ll keep your General Electric because
it still has a ways to go before it’s back to the price you paid for it. If this is
the way you think, you’re suffering from the “price-paid bias” that afflicts
95% of all investors.
Suppose you bought a stock two years ago at $30, and it’s now worth $34.
Most investors would sell it because they have a profit. But what does the
price you paid two years ago have to do with what the stock is worth now?
And what does it have to do with whether you should hold or sell the stock?
The key is the relative performance of this stock versus others you either
own or could potentially own.

Analyzing Your Activities
To help you avoid the price-paid bias, particularly if you are a longer-term
investor, I suggest you use a different method of analyzing your results. At
the end of each month or quarter, compute the percentage change in the
price of each stock from the last date you did this type of analysis. Now list
your investments in order of their relative price performance since your
previous evaluation period. Let’s say Caterpillar is down 6%, ITT is up 10%,
and General Electric is down 10%. Your list would start with ITT on top,
then Caterpillar, then GE. At the end of the next month or quarter, do the
same thing. After a few reviews, you will easily recognize the stocks that are
not doing well. They’ll be at the bottom of the list; those that did best will be
at or near the top.
This method isn’t foolproof, but it does force you to focus your attention
not on what you paid for your stocks, but on the relative performance of
your investments in the market. It will help you maintain a clearer perspec-
tive. Of course, you have to keep records of your costs for tax reasons, but