We frequently hear the stock-picking advice “cut your losers and let your winners run” (for example, see this SmartMoney article). This advice sounds smart. After all, isn’t better to own winner stocks than loser stocks? The problem here is that we only know a stock’s past and not its future.
A personal counterexample was my purchase of Apple shares in 2000 and later sale in 2003. I had lost 14% of my investment over those 3 years; so it seems that I followed the rule because I sold a loser. However, Apple stock went on to grow at an average compound rate of about 45% per year since then. My shares would be worth more than a million dollars had I held on.
Of course, one example doesn’t disprove a useful investing rule. And some may argue that I actually sold a winner that had a temporary setback. However, this is something that I didn’t know at the time I made my decision to sell. We’d like to think that we could have known that Apple had big things ahead, but this is just hindsight bias.
I’d be interested in seeing a study of whether cutting losers and keeping winners actually works in the sense that it beats the market. The study would have to precisely define which stocks are winners and which are losers based on past data and not future data. Without a convincing study of this type, I remain sceptical that this advice is anything more than a way to exploit our hindsight bias to make us feel bad about stocks that didn’t work out.