The ASX is sliding today, its second consecutive day of losses.
In early afternoon trading, the S&P/ASX 200 Index (ASX: XJO) is down 1.1%. That puts the ASX 200 down 2.1% from Monday's all-time closing high.
The broader All Ordinaries Index (ASX: XAO) is sliding too, down 1%. The All Ords is currently down 2.2% from its own record closing high, also reached on Monday.
With the major indexes, and so many of the shares they contain, slipping following all-time highs, investors may fear that a deeper correction lies ahead. And that could lead to a bout of panic selling.
But that could prove a costly mistake.
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Keep an eye on your ASX portfolio's long-term profit potential
Online trading and brokerage company eToro's Australian managing director, Robert Francis, told The Motley Fool that investors panic selling their ASX shares is an impulsive decision, "generally driven by fear, regardless of the quality, efficiency or effectiveness of their holdings".
Investors who panic sell, often forget to abide by investing fundamentals or employ proper evaluation of a stock or market conditions, and rather do so as a result of an emotional reaction.
We asked Francis why ASX investors fall into the panic selling trap. And what kind of ramification that tends to have on their portfolio.
According to Francis:
Instead of FOMO [fear of missing out], many investors who panic sell suffer the 'end of the world' syndrome, believing that if they don't get out now, and fast, that their entire portfolio will be doomed. This knee-jerk 'cut-your-losses' mindset often drives investors to make irrational decisions in an attempt to minimise potential loss, but generally just limits long-term profit potential.
Investment decisions based on fear or greed often explain why many people are buying at market tops and selling at market bottoms, despite the flawed logic behind this strategy. During the 2007-2008 market crash, the net fund outflows peaked at the market bottom, creating overly discounted investment opportunities, while fear dominated investor mindsets, causing many to avoid (and miss out on) buying back in.
Indeed, it's rare you'll find investors running for the exits when shares are charging higher. More often this will happen when they've already booked a loss on their investment, meaning panic selling will only serve to lock that loss in.
"If investors panic sell their investments during a down market or bear market, they are practically guaranteeing their loss," Francis said. "If investors maintain a long-term vision and remind themselves of the intrinsic value they identified in the company in the first place, they can preserve their long-term vision, hold on to their investments until they come back up, and avoid selling at a loss."
Know when to hold 'em, know when to fold 'em
Of course, not every share is going to gain in value. Not even over the longer-term.
At some stage, the laggards need to be identified and weeded out of your ASX portfolio.
Francis recommends the following questions and strategies to help decide when and if it's time to sell some of your shareholdings.
First, before you invest, how much do you ideally want to make on the investment? Are you happy with a 10% gain or are you after a 10-bagger (where your investment goes up 10 times in value)?
Second, take the time to analyse the type of growth you can realistically expect from any given share. Be sure to listen to some expert analyst predictions as well.
Third, after you've held onto the share in question for some time, ask yourself what value you see in the company. Do you still agree with the initial analysis that convinced you to buy shares in the company? If that analysis has soured, it may be time to sell.
Finally, have a look at the profits you've already made from a specific company and ask yourself if there's still room to grow. If you've made a large profit already, and you believe the future growth outlook is slowing, you can sell some of your shares in the company and reinvest it elsewhere.
When investors do this, Francis says, "It allows their profit to grow in the original stock and gives them the flexibility to top up their holding if the price dips."
Stop losses… fixed or trailing?
Not every investor makes use of stop-losses. But they can go a long way to preventing panic selling by taking human emotion out of the decision.
Before deciding where and how to set your stop losses, Francis says, "You should have an understanding of your risk appetite and your investing boundaries."
He continues:
Stop losses are very important in protecting your portfolio against losses. If you're an inexperienced investor and markets are more volatile, it's particularly important to set stop losses. If you're considering trading with leverage, regulators require trading platforms in Australia to implement automatic stop losses to protect investors from significant losses.
Now there are all types of stop-loss strategies you can employ. Two of the more popular and straightforward strategies are fixed stops and trailing stops.
Asked about his thoughts on these 2 exit methods, Francis told The Motley Fool:
Fixed stop losses are the safest bet to ensure your investments auto-sell if they dip below a certain price point. For the conservative investor, it may be more important to set stop losses slightly above or at the initial purchase price, so that in the event of a market crash, you neither lose, nor profit, but walk away breaking even.
For investors with slightly higher risk appetites, you may consider trailing stop losses (which trail at a certain percentage away from the share price) to maximise profit potential, especially if you think a stock has a lot of growing to do. This gives you a little more leeway to make a profit but also exposes investors to slightly more risk.
There you have it.
Despite many shares falling over the past 2 days, selling out of your shareholdings in a panic is unlikely to yield the best long-term results.
Remember why you bought your ASX shares in the first place. And if you are considering selling shares, don't do it on impulse and do stick to your investment strategies.
