Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific stock trading tips and other investment advice that will help you develop a successful approach to investing. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.

Today’s tip: “Selling a poor performer may seem like an obvious way to improve your portfolio, but make sure you are not ditching a possible winner.”

It’s a rare portfolio that doesn’t include at least a few laggards. At times like this, investors may wonder, “At what point do you give up on a poor-performing stock? How much should we be prepared to lose before we sell it and buy something else?”

That question is one I’ve heard and grappled with many times over the years. Long ago, I came around to the view that there is no simple answer that makes sense from a financial point of view.

We take notice when a stock we’ve recommended fails to act as well as we expect. We look for a cause. A stock’s performance can only tell you something if you look at it in relation to all the other information you have on it.

For instance, suppose you own a stock that is moving sideways or falling while stocks generally or stocks in the same industry are moving up. That’s not a good sign. It may mean insiders are selling the stock due to bad news that is not yet widely known.

On the other hand, stocks sometimes fall due to exaggerated or misplaced fears. Stocks can also lag behind the rest of the market or comparable stocks simply because they are out of investor fashion.

At some point, of course, the bad news or investor disfavour will have had all the impact it is going to have. This is sometimes called the “point of maximum pessimism”. If you sell stocks just because they’ve gone down, you’ll sometimes sell a stock at its point of maximum pessimism, even though that’s generally a great time to buy.

At best, you’ll miss out on a big gain. Worse, this point of maximum pessimism can turn out to be a launch pad for a major rise that goes on for years if not decades.

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The sole reason to hold on to poor performers

Some investors feel results could be improved by selling stocks that are going sideways or down, and replacing them with stocks that are rising. This can be a good idea if you dabble in junior or speculative stocks, since these stocks may suffer from hidden negatives that spur selling by insiders long before it becomes public knowledge.

With good quality stocks, you can sometimes improve short-term results by selling weak performers and replacing them with stocks that are going up. However, some of those weak performers will be at temporary lows. When a stock bounces back from a temporary low, gains can be dramatic. You need occasional big gains to produce attractive long-term results.

Above all, spread your investments out across the five main economic sectors: Manufacturing and Industry; Resources; Utilities; Finance; and Consumer. Because the sectors tend to leapfrog each other, this approach makes it almost certain that you’ll always own some stocks that are lagging behind the market.

You should only hold on to your poor performers if you believe they have the potential to turn into top performers. If you no longer believe that, get rid of them. Of course, you’ll be wrong on some of them. But if you stick mainly with well-established, high-quality companies, you won’t lose much on your poor performers, and your top performers will deliver substantial profits.

COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members

Have you ever enjoyed a big surge with a poor performing stock you decided to hang on to? Have you ever dumped a stock that went on to have a big rebound? In either case, what prompted you to make your decision? Let us know what you think.