If You're Thinking About Dumping Stocks Now, Stop!

TheStreet.com

NEW YORK (TheStreet) -- In my article published yesterday, I urged readers that have been on the sidelines during all of 2013 to resist their strong urge to buy stocks based on their anxieties about being "left behind."

Today, I will urge readers that are invested stocks, equity funds or ETFs such as SPDR S&P 500 ETF , SPDR Dow Jones and PowerShares QQQ Trust to stay the course unless and until their sell discipline indicates that they should sell.


All buy and/or sell decisions should be based on a pre-established system of clearly defined rules. To be a successful investor or trader, you cannot be making buy or sell decisions on the fly. All psychological research and applied finance studies demonstrates that making such decisions from scratch in the heat of the moment will lead to failure.

For example, in his book, Thinking, Fast and Slow, Nobel Prize-winning psychologist Daniel Kahneman demonstrates how people make terrible life decisions by relying on their "fast thinking" mental processes under circumstances when they should be making decisions with their "slow thinking" mental processes.

Nowhere is this fundamental insight more applicable than in investing and trading. As investors and traders, our "fast thinking" mental processes are constantly being swayed one way and the other by fast changing market news and the roller-coaster of emotions that are triggered by swings in our actual or potential financial wealth.


But as investors and traders, our success will be determined by our ability to stay cool under pressure and make decisions according to time-tested sound principles.

The problem is that it is simply not physically or psychologically practical to perform a brand-new thorough and rational analysis every time there is a change in circumstances. And changing prices are just one of the thousands of variables that change the objective circumstances by the minute. This is why we must follow pre-established rules for buying and selling that we follow religiously regardless of what our emotions are swaying us to do at that particular moment.

Therefore, in many ways, a sound investment decision to buy or sell is made before we are actually in the heat of the situation that requires us to execute the choice. Our task in the heat of the moment is simply to execute a rational decision that has already been made ahead of time based on sound criteria.

So, what is a buy or sell discipline? For some people, their buy discipline is simply blind dollar-cost averaging every month, whereas the sell discipline consists of rebalancing every year and reallocating to bonds according to a specific schedule as retirement approaches.

For others, buy and sell discipline is determined by the cross of moving averages. For others, buy and sell discipline is based upon buying when stocks are cheap according to Rober Shiller's PE10 and selling when stocks are expensive according to the same metric. Some people employ more complex rules and combinations of rules.

The point is this: Whatever your buy and sell discipline is, you must stick to it. Sure, you are allowed change your system over time -- if and only if you have studied the matter carefully and you think you have found a better one. However you may not change a buy or sell discipline on the fly - ever. A change in buy/sell discipline can only lead to an actual trade execution after a "cool-off" period has been allowed to elapse

If you do not have a buy or sell discipline, then you need urgently stop everything you are doing in terms of trading and investing. It is imperative that you do the proper research and adopt a buy and sell discipline that you commit to and adhere to religiously.

I happen to think that it is more likely than not that the major stock indices such as the S&P 500 , Dow Jones Industrials and Nasdaq will continue to rise in the next few months. I also think that it is fairly likely that a short-term correction could occur in the interim. I have explained the reasons for both my longer-term and shorter-term outlooks in previous articles.

However, these insights are of no use to an investor or trader if they do not have an investing and/or trading system in place that can rationally and systematically utilize these sorts of insights regarding timing.

For some investors, only the long-term matters in their buy and sell discipline, and therefore they should only heed my comments regarding the longer-term time frames. For other investors and traders that have a more short-term orientation, they may want to ignore the longer-term outlook and focus on what I say about the shorter-term picture.

Either way, whether you are a long-term investor or a short-term trader, you need to have a pre-established system in place for buying and selling. If you are a long-term investor and you are currently thinking about selling because you are nervous about stocks being at all-time highs, then stop!

Being nervous about all-time highs is not a sound reason to sell stocks. Similarly, if you are an investor or trader that is nervously watching the market make all-time highs and you feel anxious to buy because you do not want to be "left behind," then stop! All-time highs and/or a fear of being left behind is not a sound reason to buy stocks.

Take a step back, take a deep breath, get a system, and stick to it.

In the near future, I will be writing about my own systems that you can consider adopting.

--Written by James Kostohryz.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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