When to sell

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15. The most important rule of all

In Beyond the Zulu Principle, Jim Slater says,

"The oldest and best axiom in investment is to run profits and cut losses - that way profits are likely to be large and losses are bound to be small."

Never has there been a rule more honoured more in the breach than the observance. Sadly, every study on this subject shows that private investors tend to sell what they should have kept, and keep what they should have sold. This is what Peter Lynch memorably describes as pulling up the flowers while watering the weeds.

It is easy to demonstrate arithmetically why this is a bad policy. Suppose you have a portfolio of 10 shares and your annual profit target is 15%. Then say one share drops by 20%. Suddenly, your other 9 shares have to make, not 15% on average, but 19% for you to make your target. The further your single loser falls, the worse it gets.

Example

This table shows how fast the required average rises as that one loss increases, for two sample portfolios with targets of 15% and 20%:

By the time one of your 10 shares has halved, the other 9 have to average 22% apiece just to make a modest 15% target. They have to do half as much work again as you were asking from them originally. If your target is 20%, any single loss above 30% means you need your winners to beat Warren Buffett's 40-year average of 25.6%.

You are no longer on Mission Achievable, you are on Mission Impossible.

1. When should you sell? 2. What is your overall strategy? 3. Selling for passive investors 4. When to take profits as a value investor 5. When to take losses as a value investor 6. Selling for growth investors 7. Mechanical formulas for selling 8. Selling in order to reinvest 9. Stoplosses 10. The argument over stoplosses 11. Limitations of stoplosses 12. Profit warnings 13. Selling for traders 14. William O'Neil's trading system 15. The most important rule of all 16. Emotional problems 17. Conclusion