Don’t Get Married to a Stock
An important lesson in investing is not to get married to your investments. I see this happen often especially when a stock performs well over and over again. People then tend to believe that this will continue, it may but it is important to continue your analysis to see if your initial investing thesis still exists and if it is still correct. Sometimes people leave this analysis out, or when looking at data and news, they look for reasons why they are right, instead of looking for reasons why they are wrong. This is a classic example of confirmation bias. According to Kendra Cherry confirmation bias, “is a type of cognitive bias that involves favoring information that confirms your previously existing beliefs or biases.”
I will use Tesla as an example. You buy at $830, and your thesis is that as long as the RSI increases intraday, you will be long. The RSI increased every day to $900, and gave you a an 8% gain. You might think that you can get to 10%, and since it has been a great stock it will likely continue, but this is a classic case of confirmation bias. You are holding only because Tesla has been good in the past, but past results are not indicative of future performance. You got in because of the RSI, and now you are holding just because you want gains. It is important to check if your thesis is still valid. And at the $900 level, the RSI dipped intraday, so you should get out of the position since your thesis no longer holds. It is tough to get rid of a hot stock, but a strong reason to invest is critical. I always ask myself “why could I be wrong?”, and if the reasons why I am right outweigh why I could be wrong, then I invest.
When a stock rises or falls substantially it is important to figure out why, and see if after this event if your thesis still holds true. The way I personally check is to ask myself to find ways why my thesis is wrong. If your reason for investing is no longer true you must get out. There are also other safeguards to protect against confirmation bias, for example setting a price level where you would get out on the up-side and on the down-side. Regardless of what you do, acknowledge potential confirmation bias and actively fight against it.