This is the 2nd Part of a Series of Blogs - if you haven’t read Part 1 or need a refresher, then you can find it here:
Looking for ‘Excuses’ to Sell
This is very much a danger that is linked to what I have been talking about in Part 1 with regard to being unfocused in the Information Sources you use, and it is also a key Psychological failing that I know I suffer from although I hope I am slowly healing from this terrible and expensive disease. We all know the infamous and sadly banal Market adage “Run your Winners and cut your Losers” and I wouldn’t be surprised if the latter bit about “cutting Losers” gets 98% of attention from Market Players where as the bit about “Running Winners” barely gets a look in.
I am always reading/hearing about how we must “Cut our Losers” but very rarely hear anything about how to practically “Run your Winners”.
I am personally useless at “cutting Losers” after many years of trying to cure this ‘Bad’ habit, and I have pretty much given up on even bothering now - I have a partially written Blog all about my current thinking on Stoplosses but it probably won’t appear on the Website for some time - however, I now take the stance that “Running Winners” is by far the more important part of the adage and is where more focus should be put.
It is often said that you should “never fall in love with a Stock” - and for Short Term Traders this might be excellent advice and all that. However, I begin to question this more and more as a Long Term Investor - in fact, I would go so far as to say the best thing you can do is fall in love with a Superb Stock which you own !!
When I look back over many many years of my own Investing, the thing that stands out like a Sore Proverbial is how I have an elongated Track Record (possibly without parallel by anyone in the history of the Stockmarket) of Selling Great Stocks for a fraction of the Price they subsequently soar up to in following months and years. Obviously over the years I have made pretty much every mistake possible (don’t worry, I am sure I have exactly the right skills to discover some new ways of ballsing up) but if I had to list a ‘Top 10’ of WD’s dumbest c*ck ups, then Selling Fantastic Winners for a fraction of their true worth and after a small Profit has to be right up near the top.
I am now putting immense focus on avoiding this problem and setting demanding and high (but realistic) Targets helps to keep me in a Stock and I regularly now write huge Text Boxes onto my ShareScope Charts screens that I use to monitor my Holdings every night, which say something like “DO NOT SELL THIS STOCK YOU NOBBER” or that sort of thing. Maybe it will say “DON’T SELL THIS STOCK UNTIL IT HITS 550P AND THEN TOPCHOP 25% OFF”. So, in effect, during an emotionally calm and placid time of the day (actually I usually do this every night) I am setting Rules for myself with regard to an individual Stock and then if ever I get the dangerous urge to Sell, then these Text Boxes are shouting right out at me and hopefully dissuading me from Selling - it seems to be working.
Run your Winners - Momentum is a rare ‘Free Lunch’ and we must exploit it.
For a Trader who does very little Research, if any, into what a Company does or what its Value is or whatever, there is no need to fall in love with a Stock and everything is probably best being Cold and Mechanical. A Trading System should be Rules based and robotic and there is no room for affection. However, if you are a Long Term Investor and you fall in love in a deep way then you are much more likely to keep hold of a Great Stock and to let it run and to top up because you love it so much you want to really demonstrate how strong your adoration is. Topping up on your Winners is also a commendable habit to get into providing you still focus on Value and not end up overpaying.
It is obviously critical here that you Research a Stock/Company in considerable depth when you first meet on your first Date and you should only commit to a proper relationship once you know He/She is the right Stock for you. Marriage is not something to enter into lightly as Divorce can be very painful - especially if the B*tch/B*stard lets you down. If you do this in-depth research (if you have read a few of my ‘Buy Rationale’ Blogs you will get a good steer on how I go about Researching my future Spouses) then ongoing maintenance of the Marriage just requires reading RNS News Statements that the Company puts out and constant re-assessment of the Value case and the Exposure you have to your Partner and suchlike.
There is a really important concept here which chimes back to what I was saying about reading Opinions from too many People in Part 1 - I make a big thing of only reading Original Source Material from a Company first off - and sometimes that is all I read. If you read about a Company’s Results from a Secondary Source like a write-up in The Financial Times or whatever, then you are opening yourself up to being influenced by the Bias/Spin/Angle of the Author who wrote the piece. Nine times out of Ten you will probably have no idea who the Author is and no idea of their Track Record or anything - they might have started at the Paper last week for all you know. This is why it is critical to go to the Original Source and if you do read Secondary Sources ever, make sure they are from an Author you know and respect and even then you must be sceptical and question ever single line of Text you read - the Bias is hugely dangerous.
You would be amazed how inexperienced and young many Financial Writers are - I am not saying it is impossible to be Good and Young but in reality Investing/Trading is a discipline which gets honed over time and the more grey hair the better I generally find. An obvious reason for this is that Markets change and evolve over time, for example, I am currently finding the Valuations in the Market totally unlike anything I have seen before unless I go right back to the late 1990s and the Dotcom Boom - there will be very few Investors/Traders under 40 who have experienced such conditions.
OK, getting back on topic, when I talk about ‘Excuses to Sell’ what I mean is that we sometimes get an itch about a Stock we hold and probably for the vast majority of times this happens, we don’t really have an Objective and Rational and carefully thought through reason to Sell it but we just get it in our heads that a particular Stock has to go. This is so so deadly dangerous - all you are doing is stopping Momentum from helping you and making your Broker hugely wealthy and hitting your own Investment Returns - you are ‘Playing with Yourself’ (behave !!).
We get this Itch that we must sell and then we sort of inadvertently start looking for reasons to Sell - in fact, we are looking for an ‘Excuse to Sell’ which justifies our irrational impulse and calms our chaotic animal mind down. This is classic Kahneman ‘Fast and Slow Thinking’ - whenever our Fast Brains try to force us into a stupid error, we must use the Regulating Function of our Slow Rational Brain to take control and recognise exactly what is going on here. What we are doing is letting our Fast Brain create the Itch to Sell (this is pretty much unavoidable sadly) but then we are giving in to it by actively looking on Bulletin Boards and hunting out an ‘Excuse to Sell’ - when what we should be doing is calming down, relaxing, thinking rationally and slowly and putting effort into objectively thinking through whether or not we should be selling.
It’s actually worse than this. By giving in to our Fast Brains and acting on the Itch to Sell, we are feeding the Bad Behaviour and rewarding it - this is fatal because it is merely encouraging this kind of self-defeating ‘Itching to Sell’ behaviour.
Despite all I have said here, there are some occasions when it is right to call time on the Marriage and kick the swine/cow into touch. But the Key here is that we must not rush such a life-changing decision and I now tend to make Sell Decisions over several Weeks and slowly move towards taking any such action - even if it is just a TopChop.
An example of this sort of ‘Looking for an Excuse’ behaviour is if you ever sell a Stock and say something like “I sold it because I thought the last Trading Update was a bit uninspiring” - obviously this is just wishy washy nonsense and very much emotional and irrational - if you are going to Sell a Stock, have a very clear and precise and measurable Reason for why you are selling it - something like “The Stock has risen 200% since I bought it and I am now very over-exposed and it now trades on a Forward P/E of 22 and I think that is a bit too high, so I will slice off a third of my Holding” is far better.
Another classic excuse that I see almost every day on Twitter is when you Sell a Stock “because I am up 30% and I want to bank a great profit” - this is just so silly it cannot be understated - snatching at Profits in this way is cutting off the Legs off Momentum and if you use the Profit you have gained as a reason (excuse more like) to Sell, then you are clearly not understanding Value and of course you will never make a 300% gain on a Stock if you always sell them way too early when a mere 30% up.
It is all about Valuation - if you buy on a Stock on a Forward P/E of 8 and it rises to a Forward P/E of 10 then you will be up 25% - but the simple reality is that for most Decent Quality Stocks a Forward P/E of 10 is still cheap - it could probably rise as high as a Forward P/E of 15 - which is another 50% upside !! (Of course I am simplifying things here but the point is valid). So if you Sell the Stock when you are 25% up just because you have a nice quick Profit, then you are foregoing further gains and it is worse than that because the chances are that you know the Stock you are Selling far better than a Stock that you subsequently go on to buy - so in fact you are increasing your Risk (by buying a less well understood Asset) as well as missing out on Gains.
Don’t fool yourself and let your primitive CavePerson Brain fool you - take control of our own Mind and be like Mr Spock.
It is critical that we question everything and accept nothing on face value. If someone says “oh X Stock has got way too much debt” then don’t just be lazy and take that as gospel but engage your Slow Brain and dig into the numbers and check for yourself - try to understand if the Debt really is as high as they claim (it could easily be that they have a far stricter rule than you on how much Debt is acceptable or not - or it could be that they are missing the high Cash Flow nature of the business which can support a high level of Debt) and make a cold rational judgement yourself. Being lazy, whether it is by just taking the say so of another Person or by just not bothering yourself because engaging your Slow Brain is too much like hard work, is a major way in which we can hurt our own Returns and miss out on superb Investment Opportunities.
As another example, if I read about a Stock and from my own quick assessment I just cannot understand why the Share Price is going up, I put a big effort in to try and get to grips as to why this is happening - often though I can make no sense of it and of course that is time to ditch any thoughts of buying the Stock !! It is very simple for me - if I cannot understand something then I cannot buy it.
I am totally convinced that simply by engaging our Slow Brains we can get a sustainable ‘Edge’ over other Traders/Investors who just make snap judgement and emotional decisions - they are relying on their unobjective and emotional Fast Brains and this is a huge mistake.
To avoid this danger in myself, I now tend to TopChop rather than Sell the Whole Position - this stops the turmoil in my head and scratches the itch about wanting to sell but it hopefully doesn’t hurt my Returns anything like as much as Selling all my Holding of a Stock far too early.
I won’t go into this in detail, but another method that is more what I would call a ‘Trader Trick’ is to use a Trailing Stoploss which you mechanically move up behind the Share Price as it rises. For example, you could set it at 10% and you just keep moving it up so the Stoploss is always 10% behind the Current Price - if the Share then drops and hits your Stoploss, the Position is automatically closed. There is a certain elegance to this approach but it is not something I use myself. I want to be ‘Selling High’ rather than ‘Selling Low’ so if anything I am more likely to set a Target Level above the Price where I will Sell out (or TopChop a bit) - again this is something I do calmly and rationally and well in advance of the actual Decision to Trigger the Sell Order.
If you have read Daniel Kahneman’s outstanding Book, ‘Thinking, Fast and Slow’ then I am sure you will recognise much of what I have talked about here. If you haven’t read it, then pop over to Wheelie’s Bookshop and splash out the few quid it costs because this Book is life changing. It’s not a particularly easy read and you need to fully engage your Slow Brain, but it is most definitely worth the effort if you really want to sharpen up the way you think.
And just to square the circle and bring this back to the Blog Series - the key point here that I probably haven’t spelt out explicitly is that we must ‘Cut out the Noise’ because it can feed our emotions to look for an ‘Excuse to Sell‘.
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