Selling A Stock: Denial And Loss

Here's a great article saved in my computer. I do not have the link. Sorry.

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Denial and loss
Posted on 24th September 2005
by Chetan Parikh

In an investment classic “It’s When You Sell That Counts”, the author, Donald L. Cassidy, writes about the problems associated with the decision to sell.

“The process of deciding to sell a stock is a difficult one at best unless an investor has developed a discipline or methodology and adheres to it faithfully to avoid inevitable internal mental battles. When a loss is involved, the sell decision is even more difficult because the issue of pain avoidance is now present. It is human nature to seek self-preservation, and pain signals to us a danger to our well-­being. Some investors may be obsessed with safety, while most are reasonably bal­anced in their tolerance of the risks involved in seeking to earn a profit. But every investor has some threshold at which pain must be avoided, sometimes at ridiculous cost.

One of the most convenient ways to avoid the pain of loss - or even of profit squandered - is denial. Dealing with an investment or trading loss involves not only financial pain but also ego pain, a blow to our self-sense of value. A majority of stockholders at some point attempt to avoid both pains by failing to deal with the reality of their losses. They prefer not to think about it, or they minimize it. When specific stock positions go bad, the pain avoider becomes a longer-term holder, who is more accurately a collector of stocks. He has no real investment motive or astuteness of value judgment and is, in fact, simply denying the pain of potential (or already apparent) loss.

Unfortunately, most investment brokers are of very little or no help to their clients in dealing with losses - they are unwilling or unable to break down client denial or avoidance behavior. Part of brokers' inability to help stems from the bias of their training, which is strongly focused on gathering new assets and then persuading clients to buy, not sell, securities. But the broker problem goes much further.

The broker, too, as a human being is a pain avoider. He or she needs to re­main on cordial and constructive terms with clients. A successful sales person must listen to customers and act on all resulting feedback. So, naturally, when a customer indicates an unwillingness to deal with losses, his or her broker hears that message loud and clear-and heeds it. An unspoken contract between investor and broker develops: "I will not complain about my problem if you will please do me the favor of not reminding me of it."

There are several rationalizations that investors use to deny losses, or the im­portance of their losses. One relies on the rubric of the U.S. Tax Code. Investors are well aware that, for tax purposes, no loss is recognized as having occurred until a closing transaction actually takes place (and the 31-day "wash-sale rule" is not vio­lated). Using this tax reality as a psychological crutch, many investors actually talk themselves into believing that they do not have a loss until they actually take one. On objective examination, of course, such reasoning is absurd. Few such investors, holding a pleasant 200 percent paper gain, would say they have no profit!

It is, of course, possible that price might recover and today's paper loss might be reduced or recovered-or might even become a paper (or real) profit in the fu­ture. But the truth is that if the stock is quoted below what was paid, there is a loss of capital because wealth is measured by the current value of assets less liabilities. Liquidate investments under duress, value an estate, or switch investments to obtain maximum current income from available assets, and reality prevails. A stock is cur­rently worth only what it can be sold for now-not what it was bought for, what the owner wishes it would be, or what he thinks it should sell for. If current price is be­low cost, a loss exists. Period.

If an investor is too smart or too logical to attempt self-deception with the "paper-loss-isn't-real" farce, he may rely instead on a less disprovable assertion: the stock will come back given enough patience. Hope springs eternal, and once in a great while a terrible loser does reverse and rise phoenix like from the ashes. Then, the investor who has sold out at a loss and later sees the price recover says, "See, if only I'd been smarter or more patient and followed my instinct and held on, I would not have had that loss."

Closing out a position, especially when at a loss, represents the process of coming to closure.Optimistic by nature, we prefer to see our options remain open rather than have them closed off. Buying a stock involves the grand opening of new possibilities, but selling closes the final chapter. Many clo­sure processes in our lives carry sadness: graduating from and leaving our alma mater, admitting a failed marriage via divorce, burying a departed friend, cleaning out great-grandmother's attic. These represent some pretty heavy baggage, of a kind we'd prefer to avoid lifting if possible. Selling a stock conjures up such feelings, at least at a subconscious level. Holding it allows us potential for greater profit or re­claiming a current loss. If our stock is down, selling brands us with a sign of failure, which we'd like to avoid.

Actually placing a sell order and taking the loss on a final basis goes even further in that it sets up our investor for a second source of pain by being "wrong again": watching the stock move higher without being on board for its recovery. This possi­ble double horror show can be avoided by refusing to take the loss in the first place, says the denier.

What psychologists call denial is, in the investment arena, an umbrella de­scription for a variety of rationalizations and self-deceptions. All are designed to al­low possessors of losing investments to justify doing nothing about them.

There are several variations on the denial theme. One springs from the mem­ory of the purchase price, the highest price ever reached, or the best achieved since purchase. Old best price levels can each act as a high-water mark that becomes a once-was, a could-be-again, a should-be, then a will-be, and all too often a gotta-be. It does not matter how many months or years ago that high-water mark was made. It does not matter that the company's fundamentals or general market psychology has been eroded seriously. It does not matter that a rise of several hundred percent from current prices may be necessary for full recovery. To avoid accepting and dealing with the loss, the denier waits (and waits and waits some more) for recovery, denying the long adverse odds.”