It’s not what you buy, it’s when you sell


A buddy suggested I write about stocks to increase readership to this blog.  Why he thinks this is a winning strategy is beyond me.  I wrote  about the same kind of stuff in a weekly column called “Strictly Business” 87 times in four years in college but I got more attention the one time I wrote politics.  Be that as that may be, since I talk about stocks ad nauseum, I figured I might as well write about it too.

I’ve been investing in the stock market for over 10 years.  In that time, I rode the tech bubble to double my life savings, went down flaming with the dot-com burst, then did a 180 in my investing strategy as I kept pumping more money into the market.  Thankfully, the last five years has been more successful than the first to the point where, at last, I’ve recovered all of my losses and then some.  Through the good times and the bad, I learned two things:  one, even a monkey can pick a good stock and two, monkeys don’t make money because they don’t know when to sell.

It’s not hard to make an decent stock pick.  You pick a strategy, establish some criteria and do some research.  A dominant player in a stable business in a booming market that’s undervalued?  Try Sabesp (SBS).  How about an established but still growing tech stock with high gross margins and good balance sheet?  Take a look at eBay (eBay).  A company that’s sure to come roaring back when the economy goes back into full swing that also returns most of its profits to shareholders?  Frontline (FRO) is my favorite pick.  A high risk Internet Company in China?  How about sohu.com (SOHU)?  Heck, you can probably even chase Apple (AAPL) like everyone else and still make 25-30% even though it’s grossly overvalued.*  Really, if you commit to doing some studying, you’ll be able to successfully pick stocks more than half of the time.

No, the real challenges of investing are in when to get out.  The exit strategy is more difficult because, having committed the money, you’ve become emotionally committed.  If the stock doubles, greed takes over.  “You’ve made the right pick,” you persuade yourself, “so ride it out for all it’s worth.”  If the stock falls 20, 30 then 40 percent, delusion sets in.  “Don’t worry,” you convince yourself, “it’ll make a comeback because if it was a good buy when you bought it, it’s certainly a better pick now.”

These responses, so natural, is also very perilous.  If you’ve made big money, you’ll miss your chance to cash in before the stock retreats.  If you’ve lost big money, you watch hopelessly as the stock continues to tumble. Emotional buying is no better than emotional refusal to sell, but the latter is more tempting because it can be rationalized as a buy and hold “strategy.”  The truth is, there are very few stocks that are worth holding onto for a decade.  Every stock, no matter how good, eventually stops increasing; that’s a simple function of valuation.  Microsoft (MSFT) and Qualcomm (QCOM) haven’t lost much value in the last five years, but they haven’t gained much either.  Any money invested in either stocks is dead money that should be funneled elsewhere.**

Of course, it’s easy enough to say don’t let emotions dictate when you sell, but then, how should you approach getting out?

There is one scenario in which the answer is obvious.  That’s when the stock sky rockets on reasons wholly unrelated to the general market performance and to valuation.  In most cases this is a takeover rumor, but it could also be some analysts’ report that speculates on something about the company.   If the stock rises over 10% on such an event, sell it.  It doesn’t matter what you bought the stock at–whether you’re selling for a loss or a gain–just get out.   I don’t believe much in “buy and hold” strategy, but I do believe that the market  “buys on the rumor, sells on the news.”  Nothing good can come out of waiting to see what will come of the rumor.  Either the rumor is true–i.e. the market has already priced it into the stock–or the rumor is false.  Either way, the stock is unlikely to do much better.

But most of the time the signs are not that obvious and the stock’s rise or fall is more gradual.  It could either be moving with the market or against it, but I think the general approach should be the same.  The only way to divorce yourself from emotions (at least for most novice investors like me) is to set a target price on the upper end and the lower end and commit to unloading a portion of the holdings when the stock hits that number.

The target prices need not be in the same range for the upper and lower end, although you can’t adjust them as the stock moves or else you will defeat the entire purpose.  If the stock is a short-term play, you may want to make your lower target 10% below your purchase price with the upper target at 20%.  If you think the stock is a long-term value play, set the lower threshold at 15% and the upper threshold at 50%.  If you think the stock is a the next Apple, set your lower target at 50% (time to give up) and upper target at 200% (cash in your income).  You can also adjust how much of your holdings you will unload based on your confidence in the pick: for those stocks you feel strongly, commit to sell only 1/3 while those with which you are less certain, sell 1/2.

Frankly, I haven’t been investing long enough to know what the right numbers and ranges are.  But the important point is that you need to have some exit strategy before you go in.  Otherwise, emotions take over and the only time you’ll get out is when you’re compelled to do so–which is not an investment strategy at all.

This “exit strategy” should, in theory, partially protect you from the downside and partially lock you in on the upside.

How will it work in actual practice?  Ask me in a year or two when I can tell you whether I successfully purged my emotions and stuck to my guns.

*  Full disclosure:  I own a long position on all these stocks except EBAY.

**  Full disclosure:  I own a long position on QCOM, despite my full awareness that I need to get out.

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23 Responses to “It’s not what you buy, it’s when you sell”


  1. 1 Chris Schroeck December 23, 2009 at 12:35 pm

    I’ve gotten into the stock market a little bit, and it is certainly tempting to hold stocks that are losers, in hopes that they will turn around. I had one that had lost about 30%, and last year I just decided to cut my losses at the end of the year and take the loss for tax purposes. Of course, that stock is up 40% this year.

    But overall, I tend to do pretty well by taking an honest look at a company (and especially at the people leading the company) and evaluating it from that point.

    I don’t short anything, and don’t do anything tricky with options, because I’m not knowledgeable enough to do those types of things.

    One stock that I am in now that I think has a lot of potential as the economic turnaround continues is Manitowoc (MTW), which has several areas of business. It is primarily a maker of construction equipment, but also has a substantial foodservice business that ought to appreciate in the next few years. I bought in earlier this year at 9.22, and now it’s at 10.38, but I am betting on continued growth.

    • 2 joesas December 24, 2009 at 12:57 am

      Chris,

      Welcome to my world! I will write about tax write offs another time, but you’re absolutely right to consider taxes when trading stocks. You can take up to $3k in capital losses against ordinary income, which is a huge tax benefit. I personally dumped my remaining vestiges of my tech bubble disasters to turn into couple hundred dollars of tax benefits.

      It’s always difficult to see the stock you sold do better later on–which is why I recommend only partially selling the stock. One adjustment I may take when the market tumbles like it did late last year is to possible put on hold pulling the trigger if you think the general market is retreating out of sheer panic, as I thought it was last year. I only sold stocks last year because I would have been locked up once I started at my firm, not because I didn’t think the stocks won’t recover. I felt pretty confident that all stocks (save those that go bankrupt) will make a strong recovery. Those that won’t will have to be re-evaluated, but in a calmer market when emotions are out of the general market itself.

      Never short because that’s borrowing money to trade. It’s tempting, but I never do it. It would be too addictive. I hear options is a great way to make money, but you’re right, you have to know what you’re doing.

      I took a quick peak at MTW. What is it about the stock you like so much? I have to do some digging because five things really caught my eye: 1) their long term debt has sky rocketed, 2) they have taken a huge expense on something titled “Other Expenses” and it’s not restructuring charges because it’s under continuing ops, 3) their assets has gone way up but mostly in good will and intangibles, 4) their accounts receivables have greatly increased and 5) they spent a lot of cash on “other investment activities.” I suspect an acquisition explains a lot of this, but that’s a big acquisition. This peaks my interest since the stock’s been hit so hard, but I’d like to know your thoughts as I look into it.

  2. 3 rattoch December 23, 2009 at 1:15 pm

    Is it me or has the market improved before the rest of economy has. It seemed that last year the market crashed then eveerything went caput. I would think it would have the same effect when it goes back up but aparentely not.

    It seems the job market has no real correlation with stocks.

    So, much for taking all of those social economics courses, I claim to know little but enjoy following the market and economic politics.

    • 4 joesas December 24, 2009 at 12:40 am

      Chris,

      You raise a very important question. The three least reliable indicators of where the economy is and where it is headed are: 1) public opinion on how the economy is doing, 2) unemployment numbers and 3) GDP numbers. This is because all three are trailing indicators of economic health. That is, by the time those numbers turn, the economy has already headed in the direction that those numbers indicate where it is. This is easiest to understand with employment numbers. Companies would start hiring well after their performance has improved, so by the time unemployment rates begins to fall, it would be old news that the economy is doing better.

      The stock market, on the other hand, always looks to the future. It doesn’t necessarily foretell the future, but it focuses on the future. Bad unemployment numbers don’t cause stocks to fall as much as worse numbers than expected. Can’t put all the numbers in the same category. The key is understanding what they all mean.

  3. 5 rattoch December 24, 2009 at 9:23 am

    wow, i guesse i paid attention in class. maybe i am the next jim cramer lol. doubtful.

    what you said makes sense to me, the companies have to improve before they can hire anyone, if they don’t have money they obviously cant hire people. so it is usally the last thing to change.

    allegedly the real estate market is improving now too.

    • 6 joesas December 24, 2009 at 9:52 am

      Yep, I hear the real estate market’s doing better too. That will be the very last thing to get better, though. There was a huge bubble there.

      GDP and employment numbers are called “trailing indicators” because they reflect what has already happened, rather than what will happen. To be honest, I’m not sure what are “leading indicators.”

  4. 7 rattoch December 24, 2009 at 12:30 pm

    hmmm, i think how many quarters the economy is positive would be an indicator just like if there are 2 quarters of decline it is a recession.

    that is good question though, i am not totally sure.

    we obviously know it is not the stock market.

    • 8 joesas December 24, 2009 at 2:23 pm

      Chris,

      The official definition of a recession is two straight quarters of negative growth in GDP, but by the time the GDP shows that number, the economy would have been far into the recession. Similarly, two straight quarters of growth in GDP would come far after everybody would have realized the economy is in better shape. We haven’t seen those numbers yet, but don’t you think we’re now out of the recession?

  5. 9 rattoch December 24, 2009 at 3:08 pm

    i do not know. have we had two quarters of positive growth? i do not know the exact numbers.

    i think the people are still negative about everything and have not caught upto the market.

    things seem to be slowly turning around anyway.

    i blame this recession on bush, he killed the market just like he ran the other companies he was president of into the ground.

    • 10 joesas December 24, 2009 at 5:48 pm

      No, GDP numbers haven’t shown positive growth, but again, those numbers trail the reality. Same with the people. By the time people feel better about the economy, it would have long been on its way to improvement. I think we’re well on our way to recovery.

      I don’t see how Bush is particularly at fault for this recession. What policies of Bush, precisely, do you think caused this?

  6. 11 rattoch December 25, 2009 at 12:31 pm

    bush spent way too much money and started this whole debt that has lessened the value of the dollar.

    obama continued it with such great ideas as the tarp program because some companies are too big too fail.

    i do not think we are out of the recession but things seem to be picking up. i think gdp increased to 2.2 percent last quarter, not bad.

    i am worried that obama is trying to spend our way out and thus creating a lost decade such as Japan experienced. but we will see.

    i think the people will start to notice around the end of next summer. which is when i am done with school finally and will require employment so it will be good timing for me.

    merry christmas.

    • 12 joesas December 26, 2009 at 9:42 pm

      Chris,

      Respectfully, I still don`t see how Bush`s excessive spending, which I`m no fan of, triggered the current crises that started with the housing collapse.

      The economy is in good shape by next summer…

      By the

  7. 13 jason December 26, 2009 at 9:13 pm

    Thought provoking and interesting all at the time. Good job!!

    • 14 joesas December 26, 2009 at 9:39 pm

      Jay,

      Thanks! These financial posts were your suggestion, so you sorta owe it to me to read and comment!

  8. 15 rattoch December 27, 2009 at 9:18 pm

    Bush decreased the value of the dollar by spending so much money. Putting us into an even tougher situation after the housing collapse. Atleast if the value of the dollar had been higher there might not have been such a global catastrophy. We are now in a “global economy” so dollar value is crucial to our standing and power. I think we are losing globaly influence.

    • 16 joesas January 10, 2010 at 3:44 pm

      Chris,

      Foreign exchange is a topic I understand the least, but I don’t see how having a stronger dollar would have helped matters any better. Perhaps you can elaborate?

  9. 17 Joseph Lee January 3, 2010 at 4:06 pm

    NIce article Joe.

    • 18 joesas January 10, 2010 at 3:42 pm

      Joseph,

      Thanks!

      Can I get you interested in investing now?

  10. 19 Tony February 20, 2010 at 10:02 pm

    I haven’t thought through your buy/sell strategy, but it sounds like your readership strategy seems to be working :-)!

    • 20 Tony February 20, 2010 at 10:03 pm

      PS – and that was derived from an unscientific count of the number of replies to this thread :-).

      • 21 joesas February 21, 2010 at 5:36 pm

        And sometimes, unscientific methods are rather reliable! Like I say, if a book is good enough, they’ll put a good cover on it.

    • 22 joesas February 21, 2010 at 5:35 pm

      Yes, I know. I’ve been keeping track of the “hit count” and this post def. was the most popular of the recent posts (the one on Apple mouse was the least popular).

      That’s why I’m preparing a second one on the same topic!


  1. 1 Is AAPL Overvalued? « The World According to Joe Trackback on May 24, 2010 at 10:34 pm

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