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Tuesday, January 19, 2010

Try to avoid the simultaneous switch

What is a simultaneous switch? It is when you sell a stock to immediately buy another. The simultaneous switch is quite a common practice amongst small investors - usually followed by the less experienced ones. But it is a mistake, and needs to be avoided if you want to succeed as an investor.

Why is an investment mistake to be avoided? Because you end up losing money. And avoiding losses is the only rule of investing. Remember that the stock market is not a zero-sum game.

Each buy order needs a sell order for the transaction to be completed. But if you buy 1000 shares, it doesn't mean a single seller sells the entire 1000. There could be several sellers of 100-200 shares each. If the stock shoots up after your purchase, you 'win' and 5 or 6 investors 'lose' (or, 'win' a much smaller amount).

A smaller percentage of investors make money. The majority lose. To make money from stocks, there has to be lots of losers. You don't want to be one of them!

Why is the simultaneous switch a mistake? It is a form of 'timing' the transaction which is fraught with risks. One is trying to make a sale and trying to make a buy at the same time. It is a rare occasion when a good time for selling one stock is also a good time for buying another.

The 'need' for a simultaneous switch occurs during bull markets. Small investors often enter late. In an effort not to miss the bus, they end up spending all their spare cash in buying some of the 'hot stocks' that have already run up a lot.

These 'hot stocks' may not provide great returns over the short-to-medium term. As sector rotation occurs and a different set of 'hot stocks' shoot up, investors get rid of a few of the non-performers (or the ones in which they have made small profits) and simultaneously re-deploy the money into another set of stocks.

This may provide a lot of excitement, but doesn't greatly enhance wealth building. When the next correction comes, there is hardly anything left in the kitty to pick up the bargains.

In a previous article, I had mentioned three reasons why one should sell a stock. Those reasons can not be reasons for buying. Learn the mental discipline of separating the reason for selling from the reason for buying, and avoid the temptation of the simultaneous switch.

(Note: If you are not sure how to time your selling, you need to learn about and implement an asset allocation plan. Read Chapter 12: How to Reallocate your Assets from my eBook. Haven't got your copy yet? Get your FREE eBook before it is too late.)