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"Breaking up is Hard to Do"
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Breaking up with your stocks in your portfolio, that is. Recognizing your weaknesses is critical in learning and improving your abilities in everything you do. This is especially true with managing a portfolio. My personal weakness, and I suspect most others, is not knowing when to "breakup with" (sell) a stock. I have recently put a new set of rules in place for myself to try to improve this aspect of my investing. Many people that do their home work and research can pick stocks reasonably well but still do not perform well. This is at times especially true for me. Why is this? Buying the stock is pretty easy. Parting with it is so much harder. You might have a stock that is down but are hoping to make a comeback. Nobody like to sell and take a loss in their portfolio. You might have a stock that is up a nice piece of change, 5-10% or so in a short period of time. Do you sell and lock in those profits or do you risk these gains by holding hoping for increasing returns? I have no surefire way to handle this myself and do not have a plan that will guarantee you that you will sell at the right time. But, I have some ideas on the subject I am trying to put into place. I try to split my stocks into 2 basic categories, like most people I would imagine, "investments" and "trades." To me, an investment is a longer term position that I expect to do well over time. Typically, there is a good story as well as fundamentals that support this thesis. A trade on the other hand to me, is a stock that has a specific catalyst that you expect some movement on and really has no extra value after the catalyst has happened. Let's look at a couple of examples to illustrate my point. One of my earliest posts was about Cisco (CSCO) right before earnings. I believed that Cisco would beat their numbers and get a bump in the price the next day. To me, this was a trade because, it seems the trend for tech stocks in particular in the current environment is to raise on good earnings but get beaten down shortly afterwards no matter what. My thesis to go long Cisco went like this: Well, as I watched the earnings come in, I saw somewhat positive news. They didn't beat handily like I had hoped but were in line with guidance at least. But, here's where I went wrong. The CEO again, talked about the slowing financial sector and how it might impact the tech business as a whole including his business. So, my catalyst for my trade was now over and since it didn't go the way I expected, I sold almost immediately the next day. I could have made a little money instead of losing a little money by holding because of recent upgrades etc but I had no compelling reasons to hold after my catalyst broke. Now for an investment example. I recently purchased US steel (X). My thesis went like this: Based on this, I picked up (X) on a small dip and got a nice upside surprise within a week getting an 8 percent pop. I was faced with 3 decisions, take some or all off the table, hold, or increase my position on the next dip. Because I considered this an investment (longer term) for now, I ruled out profit taking. I thought that the quick gain of the previous day would retrace and allow me to by more US Steel at about $5 less than the previous day close and decided to increase my stake here. (Holding might have been the better option but we will see.) When the Fed Philly number came out looking bad for industrials the next day, I bought in for more about 4-5 bucks lower than the previous day's close. Only time will tell if these were good decisions. Like in poker, the game is not really about winning every hand but trying to always make the right decision. If you do this, you will come out ahead in the long run in poker and I believe, in investing. Like I stated earlier, my weakest part of my "investing game" was knowing when to sell. These rules I just described about categorizing trades vs. investments and when to sell are a new test for me to put a little more discipline into my strategy. For trades, I wait for the catalyst to happen and then take the profits (or losses) quickly. For investments, I try to hold and buy in on the dips while I still believe my thesis is working. When the thesis no longer works, it's time to sell and move on, even with investments. Did I panic sell Cisco too soon? Probably by a small amount, but it was a trade and not an investment for this game. It just didn't turn the way I expected. Did I lose the chance to lock in my profits from US Steel after a sharp rise in one day and end up risking more money by buying a dip? Yes, I risked a short term profit but my thesis still seems to be holding up there and I am not unhappy about a small loss at this moment. I guess we will see if this is a good strategy to pursue and no matter what, I still know I need to continually look at how and why I sell so I can become a better investor. Any comments or other theories would be much appreciated here as I know this is a difficult topic for many. Thanks and try to make good decisions as always, | ||
Comments (7)
John, it's about whether your thesis is broken or not, you add investment vs. trade which would be a time element, how long does it take to verify/refute your thesis?
Something I have thought about off and on along these lines would be what the expected annualized return is if your stock hits your target within your timeframe. If I buy a stock looking for a 20% increase in one year and it increases 10% in two or three days, now from where it lies my annualized return is 10%. If I take the quick and easy profit, my annualized return for the two or three days I held is huge.
So far so good, where I maybe get in trouble is when my treasure goes down instead of up. Now my reasoning says, from where it lies, I have a larger expected annualized return. I have a tendency to hold through which has not always been helpful.
Anyway, it's a good topic...
Tom
Posted by Thomas Armistead | February 22, 2008 2:08 PM
Hey Tom,
I haven't posted comments to my own posts until now but you raise a couple of points I did not cover well.
How long till I determine my thesis is done or broken? For steel, the rotation out of early recovery stocks, the global infrastructure play going down hill or the inability to pass along price increases would pretty much end my thesis and make me look for an exit strategy. For a trade, like a technical trade for example, it would be breaking out in the wrong direction or to level out after a breakout to the upside to end my catalyst.
Like your bond insurance investments, you seem to take a long term approach to these and make good points for doing so. But, would an actual government mandated "reshuffling of the rules" change your opinion? I would imagine you would have to rethink your current prospects for these stocks with new information and then have to consider if your thesis still stands true. At that point I would try to mentally reset my cost basis to current trading prices and try to analyze what could I hope for either short or long term and come up with a new thesis. If I can't, I sell.
As far as when to cut a sharp loser even when you think it's still good, the one thing I try to do is use Jeff Macke's advice from Fast Money and try not to let a short term trade gone bad turn into a long term investment. Working out an exit plan for an investment gone bad is certainly still a challenge to me but I do try to cut my losses when the situation changes enough to have me reset my expectations and I cannot come up with a new reason to continue to own the stock.
Thanks as always for the input.
Uncle John
Posted by Uncle John | February 22, 2008 2:51 PM
Excellent post. I think this is something we all struggle with. Most all my real life holdings are long term and I find it very difficult to make a sell decision, largely because I bought with no intention of selling.
In SLO, I've tried some trading with mixed success. In those cases, the sell decision is much easier because the buy was made with the intent of selling it after some near term event or move. 'course it also helps that there's no money on the line.
Posted by Russell Krull | February 22, 2008 3:15 PM
Unka John,
Let your Winners RIDE,
and DUMP your Losers only if the FACTS change.
Don't respond to that 1D10T - Mr. Market.
He just tries to wear you down & scare You OUT.
There's no sense in Holding Cash in a ConTest -
The Portfolio Fees eat up the Low interest
paid for the cash.
You have attracted the attention of some of the BEST SLO-1 Players. Keep UP the Good Blogging.
The worst thing that the Newbies do is Style-Drift. Plan your Work & work YOUR Plan.
The SLO plays against the BOX - the Market in general - NOT against each other.
In essence - SET your PICK - whatever your style - Growth, Value, Income, Sector Funds,
ETF's, whatever. You are judged & respected by how you oerform in YOUR chosen Arena - not in Absolute Terms -
You gotta be OLD like me -- a Neil Sedaka Fan -
Isn't he a Jersey Boy ???
Comma, Comma, do, dooby, do -wah Down.
Breaking UP is Hard to DO.
Here's your SONG :
Neil Sedaka - Breaking UP IS Hard to DO
http://youtube.com/watch?v=tbad22CKlB4
http://youtube.com/watch?v=tbad22CKlB4
Don L. Ferk
( formerly Known as VikingWarrior
SLO-1 Port : RuthLessIntent
but NOW RoiRRawGnikIV [ VW spelled backwards ] )
Posted by don ferk | February 22, 2008 10:53 PM
Uncle:
I agree with Tom on this one. "You don't regret more the things you do . . . you regret more the things you don't do." Go ahead and kick yourself for missing out on potential profits by "locking in profits", but it feels worse to blow the chance to take profits after it sinks into the abyss.
--Jonathan
Posted by Jonathan Coyle | February 24, 2008 4:41 PM
Many people that do their home work and research can pick stocks reasonably well but still do not perform well.
--------------------------
In fact, I'm finding that in many cases, even seasoned mangers many times make the same errors in judgments and perform poorly when it comes to their portfolios. Probably, they lack the necessary skills and understandings about nature of the markets or human psychology at large. I believe that the money in the stock market is probably where the long term strategy is, regardless we are in the year 2008 or any other. The true buy-and-hold investor is not concerned with whether something happens in Year 1, Year 11, or Year 111. He is invested in stocks for the long run. In the long run, you're going to be proven right, if stocks perform in the future anything at all in the way in which they always have performed in the past.
About regret:
You Are What You Trade
Terrance Odean and Brad Barber. This article first appeared in Bloomberg Personal Finance, May 2000.
People hate to sell for a loss. If you sell for a loss, you will always regret the purchase. Furthermore, if your stock later bounces back, you will regret the sale. We find that investors are about one-and-a-half-times more likely to sell any given winning stock than losing stock. This is an ill-considered policy from a tax point of view. Worse yet, most losers don't bounce back. One year after the sale, the losers investors clung to had underperformed the winners they sold by an average of 3.5 percent.
Good discussion, thanks!
Armin
Posted by astuk | February 26, 2008 6:30 AM
finding a good exit price is just as important as ploting the buy price... timing is the key to this,, honestly in this game, no one is buying to hold, thats not the competition. in most cases, buying and selling a good performing stock 5 times in 5 months proves to be more profitable than buying and holding from the start of that five month time frame. just my opinion. great post.
Posted by ntb10071981 | February 28, 2008 12:56 AM