You won’t always be satisfied with the outcome of a particular approach, and stops are no exception. This could well be the case in instances of extreme volatility where a sharply surging or sliding market can visibly and negatively affect the price you receive. Witness what have come to be termed the flash crashes on May 6, 2010, and August 24, 2015. The former experienced an afternoon market plunge, while the latter dove at the start of trading. With these scary collapses occurring nowadays (remember these events when reading chapter 31, “One in a Million”), you’ll want to decide how much weight to assign to them when charting your investment course. Some things I’d consider in these instances are the size of my position in the security or securities, my overall equity market exposure, what I think of the market’s overall technical condition, and what can happen if I’m wrong in that assessment. Perhaps you’ll want to have your financial representative contact his strategy team to review your holdings and suggest some risk management capital preservation options. As always, it’s your call.
I utilize several southerly approaches. I may have a physically placed partial stop on the position(s), as well as a portion based on my analysis of the daily closing price charts for the shares. Referred to as “line” charts, these graphs don’t reflect the shares’ trading activity during the day, just each session’s closing price quote. This approach gives the shares an opportunity to recover by day’s end and allows me to maintain the position if my key chart areas hold, but exposes me to added losses if that outcome fails to materialize and the closing price is beneath my aforementioned, physically placed stop order.
I’ve also used stops based on my technical appraisals of shares on a weekly and monthly chart basis. If I see potentially key price areas that occur in the same vicinity after applying my analysis from a variety of technical angles, I’ll assign additional import to that zone and be more aggressive in my selling—or buying—on that basis. You need to consider some sort of discipline because operating in the stock market without an exit plan isn’t a viable option.
Finally, due to the fact that the market is more of an art than a science, and because not all stocks respond uniformly to the same technical gauges, I’m not a fan of using a set percentage loss to set your stops. It may seem convenient, but there isn’t a one-size-fits-all strategy when it comes to investing. You need to analyze each stock and market individually. Isn’t the same also true in life? The way in which we convey something to one person isn’t necessarily the tone or approach we’d use in speaking to another. After all, personalities differ and people respond in varying ways, just as not all patients will respond similarly to the same medicine.
Moral: The stop order imposes a needed discipline in your investment approach. Think about your downside strategy ahead of time because the market will test it at some point. Also consider your potential market exposure in a world where rare occurrences seem to be occurring with increasing frequency. Used correctly, stops can be an aid in stopping a financial cut from becoming a financial hemorrhage and potentially allow you to remain in winning stocks longer. Their value during a bear market climate cannot be overemphasized.
Chapter 24
Ice Age
The stage is set. You’ve done your research and determined that a stock should be sold. It’s simply a matter of calling your broker or going online and liquidating it. That order is as good as executed. That profit is as good as booked. That loss is controlled. That money is as good as in your account. But then you make the mistake of, yes, thinking too much! You start to calculate the taxes you’ll owe, or worry that the stock will move higher after you’ve sold it, or think that the upcoming earnings announcement could propel the shares upward and afford you a better selling price. Whatever the reason, the bottom line is that you fail to act. Freeze might be a better word. Then the stock starts to fall, and you decide that you’ve missed your opportunity to sell the shares and hold on instead, convincing yourself that you’ll get another chance to do so at some future point. Don’t count on it. This can be a fatal financial flaw in a business where second chances are anything but assured. (The same premise applies to share purchases where a stock doesn’t give you a second chance to buy it, but I prefer to emphasize the risk side of the investment equation.)
If this were an engagement that you backed out of or a nearly finalized home purchase that you didn’t complete, you probably wouldn’t get that second chance, especially in the former case. Keep in mind that the only thing that prevented you from following through in these cases was you! You got cold feet, and for no reason other than the fact that you suddenly got too caught up in an emotional game of second-guessing yourself. That person you were engaged to and loved so much was a wonderful mate; that affordable home purchase was a sensible move for a growing family in an area with good schools. I can still remember my teachers telling me prior to a test that it’s usually best to stick with your original answer. I think the same premise often holds true in life. Don’t overthink things.
On the investment front, this reconsideration scenario is replayed time and time again in the minds of many investors. Yes, it’s natural—up to a point. We all reconsider decisions from time to time. But if you go back to the original basis on which you decided to sell that stock or buy that house or become engaged, you’d realize that the thought and time that went into those original decisions was far lengthier and more detailed than the brief period in which you second-guessed yourself. That should help redirect you to your original path.
There are times when genuinely questioning your judgment because you think you’ve made a mistake in your original thinking may indeed be warranted. I think, however, those are primarily instances where you’ve had reservations from the start, or at least frequently during the situation in question, and not when they popped up all of a sudden out of nowhere in an otherwise satisfactory scenario.
Of what value is a well-thought-out investment decision, whether technical or fundamental, if you don’t follow through on it? A psychologist I’m not, but this non-investment-related factor needs to be addressed. What good is deciding that you sincerely want to marry that special someone if you don’t commit to “popping the question”? Or failing to follow through on a business deal you’ve thoroughly analyzed and deem to have a favorable risk-reward relationship if you suddenly get “cold feet”? Is “just because” an acceptable answer?
Moral: Don’t allow a rushed, spur-of-the-moment change of mind to overwhelm and outweigh your original, well-contemplated and researched decision. And if you do have second thoughts about selling a stock but subsequently decide that you’re original thinking was sound, so what if the shares have dipped in the meantime? Go ahead and sell them anyway. The stock market doesn’t always offer second chances. Nor do life’s opportunities.
Chapter 25
Selling
This one word—selling—describes what traders and investors have tried to do successfully since the Dow Jones Industrial Average was created in 1896. Vast market sums have been lost by failing to liquidate equity positions in a timely manner. When I do my chart analysis on my holdings and conclude that a particular stock is in a weakened state and should be sold in whole or in part, I almost always sell the position “at the market” to have the order immediately executed. Hey, I want my capital returned to me ASAP! I don’t try to extract an extra several cents in a position worth thousands of dollars. That’s not a sensible risk–reward strategy to me. Don’t try to best the market by reaching for that additional bit. It’s not worth it. I repeat: it’s not worth it, and the times you successfully get that extra small bit will be greatly outweighed by the times (or possibly even a single instance) in which you fail to do so. I covered this premise in chapter 23, “Stop It,” but it bears repeating. It’s like the bull–bear market discussion we had previously; a single negative period can wipe out multiple positive ones. You need to completely comprehend this market tenet. It can be financially ruinous not to.
S
elling a stock is not the same as buying a stock. In the latter situation you are parting with your money; in the former you’re getting it back. I consider the former more important. I think this point is sometimes lost in the investment decision-making process. When it comes time to end a failed marriage or an unsuccessful business arrangement or sell a piece of property that’s weighing negatively on you, does it pay to hold out for slightly better terms at the risk of continuing down those detrimental paths? Since you’ve already made the choice to remove yourself from those situations, is it worth the extra aggravation? Or do you just “want out” so that you can relieve yourself of the stress and move on? I’d always choose the latter option. Personal situations like these aren’t just emotionally draining; they simultaneously impede you from adopting a better mind-set for future success in your other endeavors. It’s a double-edged sword. Both hurt! As I opined in chapter 10, “Mirages,” step back and look at the big picture first. It often allows for clearer viewing.
If you’re unsure about whether to sell a stock, you can consider selling a portion of it—the amount depending on how bearish you are on the shares, whether you are overweighted or underweighted in that position, and whether it’s costing you sleep at night. Then you can get a thorough research review from a respected technical analyst (or use other research avenues because the choice is always yours), and consider your risk management menu of choices. Among them is setting multiple stop orders below the market price on other portions of the position.
A goal here is to attempt to be out of a successively greater percentage of your equity position as it weakens in price, so that if the stock continues to slip or accelerates its price decline, you’re selling, for example, the remaining (and hopefully minimal) portion or portions of the position and not just beginning the liquidation process. When you’re selling a position on the way down, each prior sale at a higher price looks good in retrospect and makes you realize the value of this approach. This isn’t the conventional investment wisdom, which usually emphasizes “buying the dips.” But what happens when the dip turns into a rout? You don’t hear an answer for that one. Most importantly, this approach helps to preserve your capital, the key ingredient in the investment business. It should be most helpful with respect to declines that occur over a sustained period of time, and those that begin in the early stages of a primary bear market.
Relationship-wise, once you see the signs of a business partnership souring or cracks develop in a close personal relationship, you’re probably going to start to distance yourself from those situations.
In those instances when you sell, or are stopped out of, the first portion or portions of your position and the stock proceeds to rebound, chances are that you’ll still be holding the lion’s share of the stock. This could occur because the stock’s long-term uptrend has not been broken or a primary bull market is in force.
Finally, if you’re in a quandary about whether to sell a stock, ask yourself this question: “Will I be more upset holding the position and seeing it fall multiple points, or selling the position and watching it rise multiple points?” This should help simplify your decision-making process about whether to hold or sell the stock. I ask myself this question all the time. If the latter is your answer, then strongly consider employing some type of risk management approach to help guard against the southerly side of the investment equation. One of the ways I can tell that I really like the chart formations on a particular name is when I tell myself that I’d rather lose money buying the shares than not take the (sensible) risk in the first place. It’s the same premise when selling a stock: if the chart pattern is negative, I’m focused on getting out of it. I don’t care about missing the upside. Aren’t these recipes for life as well, when we say to ourselves that we’d rather risk being disappointed in a promising relationship than not pursue it, or not become involved in a relationship we deem risky despite some possible benefits.
Moral: When you decide to liquidate a position, it’s your money that you are removing from the market. Take it back! It’s more important to save capital in down markets than to make it in up markets. If you expect to survive the market’s sustained downdrafts, you must be willing to admit that the best opportunity to sell certain positions has probably passed and sell or start selling the position “at the market.” It’s your financial future. It’s the same principle in a relationship. When after thoughtful consideration you decide that the best times are in the rearview mirror and a change for the worse has either begun or looks like it’s in the offing, wouldn’t you start removing yourself from that situation?
Chapter 26
Asset Misallocation?
I know that I will stir some controversy (which I’ve been known to do in my career) with this chapter, but it’s necessary for me to voice my feelings on the topic of asset allocation because of what I believe is the false sense of security it can convey.
I have nothing against the asset allocation concept, where assorted percentages of one’s investment capital are placed in a variety of different asset classes depending on factors such as age, risk tolerance, investment objectives, and other considerations—thus offering a diversified approach. Asset allocation is easily one of the most spoken phrases in our industry.
A difficulty with investors having a balanced exposure across multiple categories, however, is that while they may be diversified against losing a huge chunk of their total assets in any one sector, they can also be so diversified as to minimize the impact that a meaningful gain in any one of those categories will have on their total assets. The biggest concern, however, is that there are precious few places to hide during a primary bear market, where cash is often your best friend if you don’t happen to be “short” the market (making a downside bet, as discussed earlier).
A primary bear market will often inflict a great deal of damage across a broad spectrum of categories, so that even if you’re invested across a range of investment sectors, the cumulative total of those losses can still be severe. That’s why I wouldn’t take any comfort in the fact that one happens to be “well-diversified” during a bear market. What difference does it make how seemingly well distributed your assets are if you still lose a hefty portion of your capital by remaining invested during a primary market decline? Likewise, just because you own multiple properties in a county or state won’t protect you if there’s a pronounced regional decline in real estate values.
Again, I fully understand the concept behind the approach. I get it: you don’t want to be concentrating your capital too narrowly. The potential risk is simply too great. That’s a reason why mutual funds and exchange-traded funds (ETFs) have grown to the extent they have. But in a primary bear market, cash is better than having a well-diversified equity portfolio, no matter what shape it takes. Bear markets offer little investment cover. It’s like trying to hide a sumo wrestler behind a toothpick.
Moral: So many market sayings and long-held beliefs sound better than their performance in real-world investing often proves to be—including the term well diversified. Since bear markets usually claim capital across a wide range of investment categories, diversification in and of itself is no assurance of a profitable portfolio outcome or a lessening of portfolio risk. And holding cash should not automatically be viewed in a negative light, either. After all, it’s also an asset category, and as we’ve previously pointed out, it’s better to have a very low but safe return on your idle cash than to be invested during a bear market.
Chapter 27
The Odds
The stock market is unique. After all, in how many enterprises can you be correct in the lion’s share of cases and still lose a significant amount of money? We have to stop and dwell on this truism for a while. One of the reasons that the stock market is such an amazing financial arena is that each investor sets his own odds of investment success based on his individual investment beliefs, analytical methodologies, risk management practices, and personality traits, among other consideration
s.
There are many factors to ponder. Are you short-term or longer-term oriented? What type of security analysis will you be employing? Will you be buying concentrated positions in several securities or diversifying more broadly? What’s your risk management plan? Will you be “selling short” or utilizing options strategies? Are you like the share price shoppers discussed in chapter 20, “Bob Barker,” or chapter 22, “The Macy’s Approach”? Will you be investing internationally or in mutual funds, exchange-traded funds (ETF’s), or bonds? And if so, in which categories? And on and on. With investors having widely divergent market temperaments, holding differing market opinions, and employing varying investment strategies, you can see the huge number of variables that would cause the odds of success to fluctuate so much among the investment population.
It drives me nuts when people say that the stock market is no different than a horse race or that they’d prefer the excitement of a casino. Besides, they argue, at least they’ll get their results quickly. I’ve heard these comments regularly along my four-decade-long career route. The gigantic difference between these venues and stock market investing is that in the former the odds are already set against you, whereas when investing in the stock market, you set your own odds. It’s the same premise with a relationship. You choose the variables to employ in affecting the outcome. Different choices yield different results.
What’s more, investing in the stock market is serious business. It isn’t entertainment. And if you’re treating it as such, believe me, there are far better ways to be entertained. You’re investing for a variety of reasons, including your retirement, your kids’ education, or other financial reasons that represent important considerations that can impact your life.
Relationship Investing Page 8