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Apprenticed Investor: Bite Your Tongue

Once you've maxed out your tax-deferred accounts, your goal should be to pay all the capital gains taxes you possibly can; lots and lots of 'em.

I'm reminded of an incident from '96: A friend of a friend had a huge position in Iomega (IOM). They owned tens of thousands of shares at an average cost around $5. The stock had split repeatedly, 5 for 4, then 3 for 1, then 2 for 1. This individual was sitting on what was rapidly becoming an institutional-sized position.

I asked when they wanted to sell, and got the classic answer: "Do you know what sort of tax bill that would generate?"

At the time, the stock was skyrocketing. At $50, it went parabolic. I watched this entire move, swearing I would not butt into someone else's trade. Finally, the stock went vertical, with the third exhaustion gap -- a sign that the buying frenzy was peaking. My willpower gave out: I pleaded with them to convince the holder -- not even a client! -- to at least lock in partial profits. "If you're not going to dump all of it, then at least sell half -- for crying out loud, lock in something."

All to no avail.

It's a shame when someone makes a trade of a lifetime and then blows it because of greed. The cliche is true: Bulls make money, bears make money -- pigs get slaughtered.

5. 'I'm waiting for the stock to come back to break-even.'

If you bought a stock which is now underwater, there are likely legions of people waiting for the same break-even point to get out. That's what the technicians mean by "overhead resistance."

In fact, much of technical analysis is based upon the psychology of people waiting to get out of -- or into -- a stock at a previously missed price. When a stock dips and then rallies, those who missed the previous low price wait for another opportunity to buy it there. That why it's called "support," and it's why buyers seem to appear at the same price on a chart in a given stock.

The reverse is true of sellers. Cisco is having a tough time getting through $24; every time it dips, holders kick themselves for missing that sale opportunity.

"If it only goes back to X, I'll sell there" is practically a mantra. Once a stock "breaks out" through that resistance -- preferably on big volume -- the supply of stock is exhausted at that level, and it's clear sailing to the next resistance level.

For Sun Microsystems (SUNW) that number is $5.50, for EMC (EMC - Get Report) it's $15.50, and for Microsoft it's $30. These levels are the reason why traders follow "breakouts" -- and why some stocks have such trouble returning to your break-even purchase price.

Denouement

These "words of wisdom" reflect poor decision-making on the part of investors. These fables and legends contribute to investment behaviors that can reduce gains or cause big losses. They do not contribute to a person's financial well-being.

In a forthcoming column we'll take a closer look at the other five top (or bottom) things you might say and do that ultimately undermine your investing success.



1. Expect to Be Wrong 2. Your Fault, Reader
3. The Wrong Crowd 4. Bull or Bear? Neither
5. Know Thyself 6. Prepare for Battle
7. Bite Your Tongue
Check back for more of Barry Ritholtz's
Apprenticed Investor series

Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of Burst.com, a streaming media software company. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback and invites you to send it to barry.ritholtz@thestreet.com.
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