The myth
This piece of investing advice tells investors to do 2 things: sell losing investments and hold on to the ones that are winning.
At its core, this saying advocates for rational decision-making. You need to acknowledge when it’s time to stop the bleeding and sell an investment at a loss even when it’s painful.
It also teaches investors to be patient and accept delayed gratification instead of cashing out early to get profits sooner (and potentially miss out on further gains).
The reality
At first glance, this belief seems to be a no-brainer. Who wouldn’t want a portfolio with only winning investments in it?
The reality of investing, however, is far more complicated. It can be hard to identify losers from winners, especially if you’ll only look at recent changes in prices, which may not tell the whole story.
Asset prices can move up and down due to a lot of factors that are hard to predict.
Some trends might be short-lived, and so the price fluctuations might not always reflect the “real” value of a company or asset.
Cutting your losses at the first sign of trouble might cause you to prematurely sell assets that may still recover and grow in the long term.
Conversely, upward trends aren’t always sustainable, and prices may not keep going up for as long as you hope they would.
At worst, a crash might happen and lead to big losses if the upward movement is fueled by speculation and not backed by a solid reason.
A good reason is exactly what your decision may boil down to. Do you have a good reason to sell or hold on to an investment, aside from current price trends?
To make a decision based on the right reasons, you should revisit your goals and strategy then identify whether each of your investments is still meeting your needs.
If a particular asset is underperforming, you can look at its fundamentals to know if there’s still a chance for long-term growth or if it’s indeed the right time to sell.
Verdict: It depends.
No one can predict market movements perfectly. You may save yourself from further losses by exiting a losing position, but you might also end up selling prematurely.
Likewise, holding onto a winning position could backfire if the market shifts suddenly.
You can follow this advice if you have a good reason to do so. However, it shouldn’t be used as an excuse to react quickly to trends and make rash decisions like panic selling.
Adopting a broader view and looking beyond prices and recent events can help you see more clearly and do what’s best for you in the long run.
Some brokers offer technology that allows investors to automatically cut their losses if they choose to do so.
