The reason I don’t sell stocks even though I’m predicting a market downturn, and the true meaning of “expected value”
My market outlook for 2019is a downturn toward the middle of the year.
However, on the other handI will continue to hold the stocks I have already invested in. Here, a question I often hear from members is
「If you’re expecting a drop, shouldn’t you sell?」
.
However, I do not intend to sell. This is not only because long-term investing and a buy-and-hold policy are my principles, but also because there are clear reasons.
The concept of “expected value” learned in school comes into play here
The reason is“expected value”. I think you learned this in math class as well.
For example, suppose four tickets, one of which is a winning ticket, and if you draw the winning ticket you get 100 yen, and if you draw a losing ticket you get 10 yen. The expected value here is
100 yen × 0.25 + 10 yen × 0.75 = 32.5 yen
Therefore,this lottery is advantageous if you can draw it for 30 yen; not so much if it is 40 yen.
The way of thinking about stock prices is basically the same.
Assume a stock currently at 2000 yen. I expect this stock to grow, and I think 4000 yen is reasonable.
On the other hand, if market conditions worsen, it would not be surprising if it dropped to 1500 yen. In fact, I think the latter possibility is more likely from a market view perspective.
Reflecting this market view,let’s assume a 30% probability of rising over the next year and a 70% probability of falling.
The expected value for each scenario is as follows.
Rise: (4000 yen − 2000 yen) × 30% = 600 yen
Fall: (1500 yen − 2000 yen) × 70% = ▲350 yen
Therefore,the expected value if you hold is 600 yen − 350 yen = a positive 250 yen, and since selling yields zero,it is better to continue holding.
From this view, even though you predict a 70% chance of decline, you can see why there is a reason not to sell.
Improving the sense of expected value leads to better investment skills
Here,the purchase price is irrelevant. Whether you are making a profit or a loss, the basic move in this investment game is to judge the expected value at that moment and make buy/sell decisions accordingly.
If the company’s performance becomes questionable and you must revise the fair value assumption to 3000 yen, the expected value of holding becomes ▲50 yen.At this point, you are forced to decide to sell.
The numbers that come into play here are, aside from the current stock price,purely subjective. But with experience, you can bring your subjectivity closer to reality.
This is whatinvesting skill improving means.
Of course, no matter how experienced, 100% certainty does not exist. Still, those who have managed to do well for a long time possessa strong ability to judge the expected value.
When you make buy/sell decisions, please try using the concept of expected value.
※ is also worth checking out.
