10 best performers - hold or sell?

Ben Graham, the father of value investing, once warned that "the investor's chief problem - and even his worst enemy - is likely to be himself." In the field of behavioral finance, one of the main culprits for mediocre performance is the decision by investors to sell their winning positions too soon (and hold badly performing shares for too long).

This behavioral flaw is called the disposition effect. Academics often warn that relatively unsophisticated individual investors are particularly prone to it. More recent evidence shows that even professional hedge fund managers are susceptible. It all serves as a reminder that succumbing to selling the wrong positions is something that every investor should avoid.

Why investors sell the wrong shares

The science behind the disposition effect hangs on the finding that humans tend to treat the probability of a loss very differently to the prospect of a gain. Translate that to investing, and what you find is that investors irrationally sell their best performing shares and hold the losers even if it makes no financial sense.

This theory is supported by some compelling research. Terrance Odean, a respected academic in this field, picked through 10,000 accounts held at an American discount broker between 1987 and 1993. He found a clear tendency for investors to sell winning positions over losing positions, apparently for no good reason. On average, after one year, the losing stock that was held fell by 1.0% against the market, while the winning stock that was sold actually rose 2.4% above the market.

Momentum can push winning shares even further

The research shows a clear trend for previously profitable shares to keep rising, while losers tend to keep falling. In stock market terminology this is known as Momentum. It's a powerful driver of stock market returns that's been used in the strategies of successful investors ranging from James O'Shaughnessy to Richard Driehaus and, in the UK, even the late Jim Slater.

One way that researchers have shown momentum in action is to analyse the share price movement of companies that release positive news to the market. As an example, the good news might be better-than-expected annual profits. What they've shown is that the price rise you would expect to see following the good news can actually be slow to unfold.

It's held back by investors who are suffering from the disposition effect and selling out on "good news" too early. What eventually happens is that the price drifts up over time as the market accepts the true implications of the news, which is precisely what momentum investors are looking for.

With all this in mind, Stockopedia's first stockmarket screening article of the year for Interactive Investor is a simple look back at some of the strongest performing Main Market shares over the past 12 months. We've included the price change and a Momentum Rank for each (with 100 representing very strong momentum), which scores and ranks every company in the market for the strength of its price and earnings momentum.

Unsurprisingly, the shares in the table include some of the best quality and most popular companies on the stockmarket. Shares in bookmaker Betfair had an exceptional year in 2015, with a 154% rise over the past 12 months. The same goes for McBride, a company that makes household and personal care products to sell all over Europe. It saw a price rise of 116% in 2015.

Fashion retailers are expected to to have suffered as a result of this year's mild autumn and winter (so far), but JD Sports and SuperGroup make this list. In fact, a strong theme throughout is that the best-performing companies have a high exposure to improving consumer wealth. As a result, you see strong gains by the likes of high street bakery chain Greggs, property sales website Rightmove and gaming and betting services business, Rank.

A new year's resolution

Taking profits from the best performing shares in a portfolio is very much a personal decision. But it's worth bearing in mind that human instinct makes it much more likely that an investor will bag a profit and bear a loss, even though it might damage longer-term returns.

Research shows that selling winners too soon and holding losers too long can be costly. So, with the new year upon us, it could be worth resolving to make a plan for dealing with the difficult question of which shares should stay and which should be sold.

About Stockopedia

Interactive Investor's Stock Screening series is written by Ben Hobson of Stockopedia.com, the rules-based stock market investing website. You can click here to read Richard Beddard's review of Stockopedia.com and learn more about the site.

●     Interactive Investor readers can enjoy a 2 week free trial and £50 discount to Stockopedia using the coupon code iii014 - click here.

●     To learn more about value investing strategies, you can download the FREE Stockopedia book, How to Make Money in Value Stocks

It's worth remembering that these and other investment articles on Interactive Investor are simply for generating ideas and if you are thinking of investing they should only ever be a starting point for your own in-depth research before making a decision.

*No fee for publication is involved between Interactive Investor and Stockopedia for this column.

About the author

Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.