Cold-Blooded Investing: How to Overcome Emotional Stock Attachments
by Marc Lichtenfeld, Advisory Panelist
Wednesday, June 30, 2010: Issue #1292
When it comes to picking stocks, some investors study a company's fundamentals. Ratios like price-to-earnings, price-to-sales, price-to-book, or the cash flow statement.
Others prefer to analyze a stock's technical aspects, looking at moving averages and support and resistance levels so they can weigh the best time to buy.
But with some stocks, it's not the fundamental or technical aspects that take center stage. It's the story...
Saving Lives... Making Money
This is often the case with healthcare stocks - particularly the smaller names. And it's not surprising that investors get excited about owning shares in companies with potential breakthrough drugs.
After all, who wouldn't want to be involved with companies that are saving people's lives or relieving suffering? At a cocktail party, do you want to talk about steel stocks or the $2 stock that could go to $50 if its cancer drug is approved?
It's compelling stuff.
When I first was licensed as a Wall Street analyst, I covered retail stocks. Being a stock junkie, it was interesting. But after a while, same-store sales figures didn't provide that rush I craved. I needed more.
Biotech provided it.
I'm half joking here. You should never invest in stocks because you need the adrenaline rush. But being a writer, and also an analyst, I always wanted to tell a story as well as crunch the numbers.
But here's one of the downsides of a "good story" - and what to do when you become too attached to their stocks...
You Hear That Voice? It's the Voice of Reason
The primary reason for buying companies with feel-good stories is because investors want the story to result in a higher share price - and in turn, produce a sizeable profit when they sell the stock.
But when you become too attached to the story at the expense of reason, not selling the stock can prove disastrous.
Sometimes we're blind to evidence that the company/drug isn't all it's cracked up to be. Other times, we ignore our trailing stop discipline because we just can't let go of the story.
The MELA Story
I've advised the subscribers to one of my services to buy shares of MELA Sciences (Nasdaq: MELA) on two different occasions.
- In March, we grabbed a 42% gain on the stock.
- And when it fell, we bought on the dip and cashed in another 39% gain earlier this week.
The company makes a device called MelaFind, which tells doctors whether they need to biopsy for melanoma. MELA Sciences has concluded Phase III trials on the device and it will go before a Food & Drug Administration (FDA) panel review in August. The panel will then recommend to the FDA whether or not MelaFind should be approved.
If the FDA determines that MelaFind is effective and approves it, the device could save a lot of lives, as it would detect melanomas that physicians might otherwise miss.
Do I think the FDA will approve it?
Well, I'm actually not as confident as I used to be that we'll see a positive outcome (for reasons that I can't go into in this short space).
So I advised my readers to pull the trigger and sell the stock.
It was a tough decision. I've followed the company for several years. I personally like the CEO and believe he's firmly committed to saving lives.
In short, the story is as good and emotional as it gets. But when it comes to investing, emotions are dangerous.
Two Quick Steps to Becoming a Cold-Blooded Investor
When I came across some new information that made me question my original investment thesis, I couldn't ignore it.
After issuing the sell recommendation, I wasn't surprised to receive some e-mails from people, saying they're going to hang on because they still believe in the company.
I hope they make a million dollars on it because that would mean that MelaFind is successful and lives are being saved. And if I failed to present a convincing argument against the stock, that's my fault.
But if they're holding onto the stock for no reason, other than that they've become so emotionally invested in the story, that's a recipe for disaster.
So if you're holding shares of companies that have compelling stories and have an emotional component, take the following steps...
- Set a Trailing Stop: We've said it here many times before - and for good reason. Doing so makes the sell decision an automatic one and removes all emotion from the process.
- Phone a Friend: Every so often, tell the stock's story to someone who knows nothing about it. See what their reaction is. Listen to their questions. First, see if you can answer them and then how well you can answer. Seeing it through the eyes of someone who isn't already emotionally involved and has money on the line may reveal issues that you hadn't thought of (or chose to ignore).
In conclusion, let other investors' emotions fuel the run-up in your stocks. Just be sure to keep yours in check so that you can get out while the gettin's still good.
Hoping your longs go up and your shorts go down,