7 Common Trading Mistakes Part 6: Selling stocks after years of poor performance
Lots of people become discouraged with stocks in their portfolios that have under-performed for years. GE is a good example. As of late 2017 GE has under-performed the market for years. Emotional investors cannot resist selling a long-term underperformer when that stock that takes a quick upward jump. It feels bad holding these stocks. Every time you see them in your portfolio it hurts. Every decision in the past to hold the stock in hopes of a recovery have been shown to be mistakes. The pain become unbearable and the stocks are sold at a long-term capital loss when the stock finally recovers a little. Based on evidence that is a mistake.
Evidence shows that long-term under-performance (two or more years of large under-performance) tends on average to be followed by superior performance. So investors would do well to hold such stocks and perhaps to consider buying stocks that have fallen into huge long-term disfavor. Note that retaining a stock with huge long-term capital losses offers the tax advantage that if the stock does recover the forward-looking profits offer the tax-advantage of merely reducing long-term capital losses. Short-term capital losses are often worth “harvesting”, but there usually is not much of an advantage to taking long-term capital losses (unless it is being used to offset long-term gains).
Evidence indicates that viewed with a horizon of at least two or more years, there is a tendency of stocks that have experienced large price changes to “mean-revert” – meaning that they move back towards long-term averages. This means that long-term, large increases (five or more years) tend to be followed by mediocre performance. Buying a stock that has substantially outperformed the market for five or ten years is not wise. IBM has been a good example of this phenomenon over the last 70 years. Evidence also indicates that long-term, large declines in a stock price tend to be followed, on average, by several well-performing years. So when long-term performance is involved, based on historical patterns the “trend is not your friend”.