I wanted to take a moment to talk about exit strategies. There’s alot more to this than a brief blog post has room for, so I plan on addressing this in a subsequent column.
Lets look at Apple, circa 1999 and 2005. It demonstrates two common mistakes investors make — they don’t hold on long enough, or they hold onto a stock too long.
If you bought Apple when co-Founder Steve Jobs returned in the late 90s, the stock rode the newly introduced iMac from $13 all the way to $150 (split adj). If the phone call questions I got on AAPL were representative of many 90’s buyers, than too many investors rode it right back down to the teens.
Fast forward a few years: In 2003, Apple is trading in the mid-teens — a coupla bucks over cash on hand. I spoke about the stock to many investors (insitutional and otherwise). Again and again, I saw people who owned this in the teens sell it in the $20s or at $30.
Why? "Cause its a winner in a tough market, and we need to lock down some profits" was the answer, again and again.
That’s essentially 2 mistakes in one: 1st, on a relative strength basis, you should hold onto strong stocks in a week market. 2nd, selling something merely because it went up is no strategy — its a guess. I certainly understand when a fund manager has a position which balloons to too big a percentage of their holdings, so they must do a little trimming; But merely saying "I’m selling this cause its gone up" is no strategy at all. Even worse is "I’m shorting this because its been so strong" ala the home builders. Ouch . . .
I’d be curious what rules other fundies/technicians use for sells. I’ll start with two basic ones:
Rule 1) if a stock breaks its uptrend, I’ll sell.
Rule 2) on a runner like Apple, if it gives back 20-25% of its profits, it is a sell. If you own AAPL at $15, and now its $85, you have 70 points in gains. A sell off of 15 points, and I’m likely gone.
Any other exit strategies out there?
Everyone has (or should have) exit strategies. I tend to think of my exit before I even put a position on. Not only does it keep me honest while holding and subsequently selling, but it also forces a systematic approach to the initial purchase. Let’s say I buy a junior gold miner — why? If I simply think I know something about the geology of the claim in that random third-world country, perhaps I rethink. If I think I know something about the management, the balance sheet, and the gold market, I can buy knowing for what I’ll be watching during my holding period, and what would spur me to add, reduce or exit.
One note, though: “sell because it’s up” and its mirror image “buy when down” is a strategy, it’s just neither fundamental or technical: it’s a short-volatility strategy (momentum traders have the opposite implicit bet; they’re long vol). Try adding a volatility proxy to your post-hoc regressions. I did, and ended up with a significant coefficient at .10; it wasn’t a large exposure (-5% or so) but it did find the effect. It’s probably because mechanical sell-when-it-balloons can systematically enforce selling on the way up.
As a technician, I like the following exit rules:
– wait until the stock builds a base and breaks (i-e the reverse action that preceded the uptrend),
– measure the longest pullback (in percentage) the stock made during the uptrend and use this as a trailing stop.
Sell Strategy
The Big Picture has an interesting set of posts on selling strategies.
The author first
presents…
My sell rule is simply the opposite of my buy rule.
First, I only buy when I think it is going to go up. No matter how much I love the company/product/management/technicals, I only buy if I think it is going to close the day higher than my entry. If I was right, I only sell thereafter if I no longer think it is going to keep going up. I’ve gotten out too early, too late, and just right. What I’ve learned is that psychologically, I am way more comfortable missing the bottom and catching it on the way up, and then missing the top, and getting out on the way down. My ideal trade looks like an upside down check mark.
There are an infinite number of reasons why I might think it is going up, but whatever they are, I sell when whatever reason caused me to buy no longer holds. If the reason relates to valuation, then its a price trigger. If the reason relates to management, product, competition, etc., then the trigger is news based. If the reason relates to technicals, then it is a technical trigger. More often than not, it is a combination of all of these. In all cases, I sell when at least one of the reasons that made me think it was a good buy starts looking sketchy.
The bottom line is that selling totally depends on why you bought, with one more exception. I also sell if I was wrong the stock goes down right after I bought it, even if my reason for buying hasn’t changed. I don’t fight the tape.