When to sell? It’s one of the toughest conundrums for investors and inevitably gives rise to some of the psychological and behavioural biases that human beings are prone to. Does the answer lie in disciplined rules-based investing? One method that we have flirted with in some of our model portfolios could be to look at a security’s 10-month moving average price and sell when the current price falls below this level. The time to buy back in is when the price is back above the 10-month moving average.
Potential advantages of this approach are that investors have a built-in mechanism to ensure they ride momentum – which when in full flow has been the most significant outperformer in terms of factor returns that the stock market has known. On the other side of the coin, investors also give themselves an automatic stop-loss to get out of positions with negative momentum and avoid value traps. The main drawback is that movements in some volatile asset prices can precipitate trades that, in hindsight, seem unnecessary and result in irksome charges.
Does the rule work in practice?