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Life Guide U.S. essentials
English

Sell stocks that have lost money by a rule you set in advance, and don't count on averaging down to turn things around

  • Moderate value
  • Evidence A
  • Saves money
  • Free
  • Takes minutes
  • Some willpower

In plain words

People's instinct is to sell when they've made money and to hold on grimly when they've lost. In seven years of records on 10,000 American accounts, stocks that had risen were more than 50% more likely to be sold than stocks that had fallen. The same people were also keener to add to losing stocks. Yet the losing stocks they kept did on average 3.4 percentage points worse over the next year than the ones they sold.

Cost

Free. The hard part is admitting that this one has already lost money, and then selling it.

What you get

This study looked at all the trading records of 10,000 accounts at an American discount broker from 1987 to 1993. The proportion of gains realized (PGR) was 0.148. The proportion of losses realized (PLR) was 0.098. The difference is 0.050, with a t value above 35. On a daily basis, stocks that had risen were more than 50% more likely to be sold than stocks that had fallen. The same accounts were also more eager to add to losing stocks. The share of losing stocks bought again was 0.135, against 0.094 for winning stocks, with a t value of 19. The study also tested the idea that "the ones you keep will come back up." The result was the opposite: the excess return in the year after of the winning stocks sold was on average 3.4 percentage points higher than that of the losing stocks kept. Excess return means the part above the market index. The author also worked out an example using averages. Selling 1000 USD of stock, selling the loser rather than the winner gave a return about 4.4% higher over the following year. That 4.4% includes the tax saved by taking the loss earlier. The tax offset is calculated under the U.S. tax system (United States, 1987 to 1993)

Notes

This item is about "whether to sell," while §5.15 (don't trade stocks often) is about "don't keep acting," and the two do not conflict. Setting the rules in advance and following them actually means fewer trades. Averaging down is arithmetically correct: buying a bit more does lower your average cost. What is wrong is treating it as a way to turn things around. Its actual effect is to increase the money you have riding on this one stock; see §5.19 (don't put all your money on one stock). The tax offset part is calculated under the U.S. tax system and does not carry over to China, and the rest still holds. These are American account data from the 1980s and 1990s, and the trading costs and tax system of China's A-shares are different. This is not investment advice.

Evidence grade
A : Specific numbers from meta-analyses, large cohorts or randomized trials; for law and policy, the statute or official text.
Sources
  1. Odean T (1998). Are Investors Reluctant to Realize Their Losses? The Journal of Finance 53(5):1775-1798. https://doi.org/10.1111/0022-1082.00072

Translated from the Chinese original. Original book, section 5, tip 37. This section is about money and spending. It is general information, not financial or investment advice. Content may be out of date and rules differ by place. When you actually deal with an agency, a doctor or a court, follow what local officials, doctors and lawyers tell you. Disclaimer