When a Winning Stock Starts to Own You
"If you have a small stake in a company, you own the stock, but if that stock suddenly grows enormous, the stock owns you." - Jason Zweig
Hey There Mindful Investor,
Jason Zweig's quote captures a problem that most investors would love to have. You buy a stock, the investment works incredibly well, and the position becomes one of the biggest winners in your portfolio. But as that stock continues to appreciate, something interesting happens. What began as a relatively small investment can become an increasingly large percentage of your portfolio, and the better it performs, the more important that single position becomes to your overall results.
That's great as long as the stock continues to move higher. If you identified one of the leading growth stocks during a powerful market advance, allowing that winner to run can generate tremendous returns. But no uptrend lasts forever. Eventually, even the strongest stocks will stop making higher highs and higher lows. At best, the stock may begin moving sideways and enter a period of consolidation. At worst, the trend can reverse completely, producing a significant drawdown that quickly erases some of those fantastic gains you enjoyed on the way up.
The better a stock performs, the harder it becomes to let go of it
The challenge is that our relationship with the position changes as it becomes more successful. We remember how much money it has made for us, and we become increasingly reluctant to let it go. The stock becomes part of our investing story, perhaps even one of the decisions we're most proud of making. That's when Zweig's observation becomes especially relevant. Instead of simply owning the stock, the stock begins to own us. Our emotional connection to the position can become strong enough that we ignore evidence we would recognize immediately if we were looking at someone else's portfolio.
The fix is trading an emotion based process for an evidence based one.
This is why I often encourage investors to evolve from an emotion based investment process to an evidence based investment process.An emotion based approach allows fear, excitement, euphoria, and desperation to drive our decisions. We panic buy because we're afraid of missing the next move higher, and we panic sell because we're afraid of losing what we've accumulated.An evidence based approach focuses instead on the chart itself. As long as the trend remains healthy and the chart continues to demonstrate positive characteristics, we have a reason to maintain exposure. When that evidence changes, we should be willing to change as well, regardless of how much we love the company or how well the stock has treated us in the past.
Ask the "new money question" before deciding whether to hold.
One of the best techniques I've learned for breaking that emotional connection is what I call the "new money question." Imagine that you didn't already own the stock and had new money to put to work today. Looking at the chart right now, would you choose to invest that money in this particular stock? That simple thought experiment removes much of the history from the equation. You're no longer thinking about where you bought it, how much you've made, or how important the position has become. You're simply evaluating the opportunity based on the evidence available today.
If the answer is yes, then continuing to own the position may make perfect sense. But if the answer is no, then you should probably ask yourself a second question: if I wouldn't put new money into this stock today, why am I so comfortable leaving my old money there? That doesn't necessarily mean you need to immediately sell every position that has stopped outperforming. It does mean you should make sure your decision to hold is based on current evidence rather than an emotional attachment to past success.
Own the stock. Don't let it own you.
Winning stocks can transform a portfolio, and we should absolutely allow strong trends to work in our favor for as long as possible. But the goal is to own the stock without allowing the stock to own us. A disciplined investor appreciates what a great position has accomplished while remaining willing to move on when the evidence suggests that the opportunity has changed.
Mindless investors become emotionally attached to their biggest winners and continue holding because of what those stocks have done in the past.
Mindful investors regularly ask the new money question, evaluate every position based on current evidence, and have the courage to take action when a winning trend finally changes.
RR#6,
Dave
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Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional. The author does not have a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author and do not in any way represent the views or opinions of any other person or entity. For full disclaimer, please see our website: marketmisbehavior.com/disclaimer.
