While there are many different strategies in trading, there is only one way to make money, selling our winners. As obvious as that sounds, all too often people forget this fact, especially during periods when prices have done nothing but go up.
A person feels wealthy when they own a bunch of expensive stocks. But this person doesn’t have money, they have stocks. And the quirky thing about stocks is they are only worth what someone else is willing to pay for them. Same goes for any other asset whether it is real estate, commodities, or cryptocurrencies.
If a person has 50 bitcoin, it would be easy to assume that person has half a million dollars at BTC’s current price of nearly $10k each. But that person doesn’t have half a million dollars, they have 50 bitcoins. The person only has half a million dollars if they sell their bitcoin for $10k each.
After prolonged rallies people naturally become emotionally attached to a position that has done really well. They held through several dips along the way and were rewarded for their patience when the stock rebounded even higher. This positive feedback loop encourages long-term holders to keep holding no matter what. But the thing to remember is every dip bounces……until the one that doesn’t.
Markets overshoot. That’s what they do. The hotter the stock or commodity, the larger the overshoot. That’s because people love chasing winners. They see other people making money and want to jump on the bandwagon. Who doesn’t love a good bandwagon?
What starts as a fundamentally sound investment quickly turns into pure speculation. After a while gets to a place where even the most optimistic fundamentals cannot support the current market price. But it doesn’t matter because people are no longer buying it because of the fundamentals. They are buying it because the price keeps going up. Buyers assume someone else will come along and pay even higher prices.
This happened in internet stocks, real estate, oil, 3D printing stocks, and now it is happening in cryptocurrencies. Disagree with me all you want, but people are not buying BTC because of the underlying fundamentals. They are buying it because it doubled in price this month. At some point we run out of new fools willing to pay even higher prices and that is when the house of cards collapses. But it gets worse. What started as an irrational overshoot to the upside quickly turns into an irrational overshoot to the downside. When these bubbles finally pop, prices plunge an average of 80%. That’s not speculation, that’s fact. Anyone who claims “this time is different” has not been doing this very long.
Most of us are in this to make money and the only way to do that is selling our winners. That means overcoming our attachment to our favorite positions and saying good enough is good enough. People who become irrationally attached to their favorite stocks inevitably hold too long. The dip that was supposed to bounce doesn’t bounce. But that is not a big deal because they just need to wait a little longer. A little bit later prices fell even further. But this happened before and they just need to keep waiting. Eventually prices fall so far that fear, regret, and hope are driving a person’s trading decisions. Actually “decision” is the wrong word, it would be more accurate to call it “indecision”.
Remember, we’re in this to make money, not own stocks. We only make money when we sell our best positions. Don’t make the rookie mistake of holding too long. While some people will make staggering profits on AMZN and BTC, even more will watch eye-popping gains devolve into heartbreaking losses. The only way to avoid becoming one of those people is to sell your favorite positions.
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Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two young children.