Everything in this entire book up until now has concentrated on the two skills of mastering yourself and getting into the stock market sensibly for reasonable returns in the future. But what happens when the future arrives? If you made a mistake it could be the very next day. It could alternatively be a decade away. Eventually the future will arrive on your doorstep and you will have to decide when to sell your treasured investment.
It is now time to help you to master the art of getting out and running away, and it is not as easy as you think. Once you have felt the pleasure of seeing your hard earned money grow and sometimes multiply through wise investing, you will become a stock market junkie just like the rest of us! In many ways successful stock investing is an addiction like any other. The pleasure hits to the brain can be so powerful that they become a drug and override your common sense. They make it nearly impossible to reverse the decision making processes you have grown used to, even when logic is staring you in the face. At the end of the day, while you are still holding a company and you are in profit, you have only created value. It is when you actually sell that you have created a cash profit.
If you would like to learn about the art of selling in more detail then I highly recommend a powerful book I once read called “It’s When You Sell That Counts” by Donald Cassidy. It contains many great truths about the interface between human psychology and the skill of selling. I was literally embarrassed to see myself described on so many pages while Cassidy was telling me what not to do! I am going to begin by giving you a list I have compiled of all the selling mistakes I have made personally. I do this in the hope that my hindsight will become your foresight. These stories will make you laugh…until the day you make them yourself. Remember, mistakes are our tuition fee in the school of hard knocks so I had to make them or I would have learned nothing in my early years. The point with mistakes is to makes sure you do not lose too much of your seed capital in the process. I am still making selling mistakes and always will. The point is that my mistakes are costing me less and less as time goes on while my correct decisions are making me more and more profits. Investing can be learned no other way.
WHEN KEVIN SOLD AT A LARGE LOSS
For me, to sell at a loss is akin to experiencing the amputation of a mutilated arm which is giving me great pain and must be removed. I must choose between the continued agony of a deep wound arm that could get gangrene or the finality of never having it again to love and hold. But I want the arm! To keep a losing stock is to hope for a recovery of the arm when you know it is beyond repair. There is no financial return on capital in this situation while leaving open the possibility of a further loss of capital. Because human hope and fear are both tied up in the continued holding of a losing position, this is one of the hardest pieces of self-discipline to me to follow… ever! I have watched investments go to zero several times and all the while I was unwilling to sell them at a loss. Intellectually I know that once the price has drifted below purchase a loss exists, regardless of whether it has been sold or not. But emotionally I justify the paper loss by saying to myself that it is only a temporary setback and will turn up soon.
So you see a typical investor like me will not sell at a small loss. If the stock is in deep trouble and continues to slide, the loss will usually tumble downhill like a growing snowball till the pain is unbearable. Mr Alan Average will hold on and on in unrealistic hope of a turnaround in company fortunes or stock price, which never eventuates. Then Alan Average will sell in panic with the crowd at the bottom of a correction when the stock price is plunging steeply. This is when the pain of keeping the investment becomes less than the pain of removal. Amputation day has arrived. It is the same problem my high school students used to experience when they are given an assignment. In the first week or two the pain of starting the assignment was far greater than the pain of failing as they had only accumulated a small time deficit to do the assignment. This procrastination continued and the time deficit slowly built up until eventually the deadline loomed large. Then the pain of failing in a few days became greater than the pain of starting the assignment. The psychology of selling stocks at a loss is very similar and likewise fought with procrastination and high emotion. If the company is going broke, or the market has turned bearish for any of a hundred reasons, the final capitulation price plunge brings everything to a head with hundreds of forced and emotional sellers pushing through the eye of a needle to get out. Price becomes irrelevant and emotional closure is all that matters. In these situations volume will spike to levels significantly above normal. This is when seasoned bargain hunters come out of the shadows and begin snapping up stock at a fraction of the normal price hoping for a rebound. This is the perfect buying opportunity if it is a good company that has been dragged down with the crowd.
With one company I bought a few years ago, a speculative technology stock, I kept living in hope until I lost 90% of my capital. Only then did I pull the plug. The company eventually went to zero. At the time of selling I felt very low as I had come so close to selling earlier when I had lost a mere 50% of my capital. However after the company was de-listed I felt like a smart guy. Only the future decides if your sell decision was wise. Ignore present emotion and follow logic. Back in the 1990’s, in the age of personal brokers, I ignored the advice of my broker who told me that company X that I was invested in was about to go broke. It went broke and I lost all my capital. Because I lean more on fundamental research I am a sucker for hoping bad situations will turn around one day, hopefully tomorrow. Fortunately, with ten years of hard knocks and hard-earned rat cunning under my belt those days are over, I hope.
WHEN KEVIN SOLD FOR A SMALL LOSS
A forced change of mind soon after a purchase, due to having made a mistake, is an ego embarrassment for me, but I have become much more humble with age and wisdom. Selling doubles the pain but I am getting used to it. Fortunately I am slowly becoming more nimble with experience. After many disasters like those mentioned above I have instituted rules so that if my investment goes backward by 20% I will sell regardless of how good the story sounds.
However, the less time I have held a company has, the harder it is for me to switch from a purchase mindset to sell mindset. I am getting better at making my sell decisions based on the likelihood of further loss, not on the time period held or the reasons why it was purchased. Like getting out of a bad marriage before things get worse, a good sale out of a bad company does not necessarily mean selling at a profit. It may mean selling before a loss gets bigger. It is only after I sell that I will know if I have made a good decision. I have learned that a successful sale can only be defined by events that follow the sale.
In 2012 I saw a micro-cap gold explorer operating in Papua New Guinea that looked like it was on to a good thing. I phoned management and had a chat, then threw in about $20,000 when I thought the chart was on a low. However it soon began to drift below my purchase price. I was expecting a big response from the market when the deep drilling came out but in the run up to it the price was going down instead of up on anticipation of the result. This should have been a signal to me that the insiders were selling. It was the first time I had bought promising myself I would sell if I racked up a 20% capital loss but alas I still couldn’t do it and let it drift down to a 40% loss. The day the drill results came out they were poor. I sold immediately into weakness for a 50% loss. I didn’t care what happened tomorrow. I had broken my rule and had to now take the discipline the market had dealt me. Almost a year later the company had still not performed and languished near the price where I sold. When a stock price slips below purchase price it is common for investors to switch from using technical indicators to evaluate the company to fundamentals. I made this very mistake to justify holding onto the purchase and as a comfort in the face of a loss of capital.
Needless to say I am now ruthless with my 20% loss rule and don’t believe in living in hope any more. But it has taken me a decade to learn this lesson. My ego is always my worst enemy. I can safely predict it will be your worst enemy as well. Please learn from my mistakes. I cringe when I think how much further ahead we would be if I had implemented disciplined selling rules years earlier. Pride comes before a fall and in the world of capital allocation your pride and ego are the most expensive things you ever own. The company I bought into after this episode also went south but I was able to exit without fear of missing the turn. A decisiveness and confidence has now entered my selling that I never had before.
Lest you think I am disobeying all my own buying advice I have given you up until now in this book, I need to add before moving on that these losses I described above are very small and only occur within the 10% of my capital that I allow to be used for buying into higher risk companies. Each purchase only represents 1-2% of my total capital so they are very small economic experiments.
If you have had to take risks in the past in your own personal life then you have already fallen on your face and learned how to dust yourself off and start again. People who have been used to these highs and lows are better naturally better conditioned psychologically for the realities of buying and selling stocks. They are better prepared for the risks of the markets than those of us who had comfortable upbringings where their needs were provided well and they learned to expect certain levels of attainment and refinement in life. In addition to this, people who are conservative by nature and with their finances are probably going to experience too much fear to handle the natural volatility of the market place.
If you have had a series of losses in the market, it might be wise to sell up and step aside for a while to evaluate what is going on. To lose money after two or three attempts at investing is to take an enormous blow to your ego and confidence. From this point on you will be desperate to get your money back. This guarantees you will make further mistakes as you simply must make money. Investing out of desperation always ends in ruin. I tried to become a full time futures trader in the late 1990’s but failed instantly because I needed whatever profits I made to support the family. I had to make money or else. Of course I failed dismally. Profit comes to the confident. When you lose your confidence it is time to walk away for a season so you can contemplate your mistakes. After my failed attempt at futures trading I walked away from all forms of investing for over three years. It took that long to clear my head.
WHEN KEVIN MADE A SMALL PROFIT
They say the best way to make a million dollars in the airline industry is to start with a billion and run the airline for five years. I have often been like that. I have watched a company’s stock price rise beautifully, sensed it was time to sell, became greedy for more and had to settle for a mediocre profit in the end as it tumbled away. We humans hate coming to closure when experiencing pleasure, therefore it is very difficult to sell after a profit has been created on an investment and it turns down.
Consider how many people watch their home rise in value during a real estate boom. Then when the market turns south and it is their turn to sell for whatever reason, they refuse to meet the market and the home for sale for several years. Some family members of mine experienced this very thing and sat in a home for two years waiting for a buyer. Every six months they dropped the price, but every time they did the market had dropped further. The original sale price of $630,000 finally became a sale of $500,000 with two years wasted sitting and waiting.
Stocks are exactly the same. In early 2012, I watch as a company I bought five months earlier, Cougar Metals, soar from my buy price of six cents up to eleven cents. I absolutely knew it was overbought, as every technical indicator was flashing red, but I wanted an extra cent. It began to descend and I made my first sale at eight cents. I felt lousy even though I had made a handsome profit in percentage terms. Then I made another big sale at six and five cents. I sold the final tranche at just over three cents. I came out with a very modest profit. I knew exactly what I should have done but in real time greed takes over and getting enough was just a little bit more than what I had. Part of my psychological problem was making the mental switch from enjoying the run to selling and moving on. I couldn’t, or just wouldn’t switch from loving what was happening to rejecting the company and leaving it behind. It was just too hard. If you want to become an investor this is one of the most important lessons you will ever learn. Learn to read your greed barometer.
So, on those odd occasions when you already own a stock and suddenly the clamour to buy is getting out of hand, with valuations over-extended and trading volumes exceedingly high, it is time to say goodbye. However, to actually sell will feel stupid because of the perception of cutting off future easy gains. Good investing requires you to lean into the wall of worry when buying and against the wall of greed when selling. Always do the opposite of what your emotions are telling you. Learn to fight greed. Please don’t repeat my mistake!
In retrospect another of the issues that caused my downfall with this investment was waiting for an even number to come up. Humans dislike odd numbers and love even numbers. I have learned to never put a sell order in at an even or a round number, especially neat dollars such as $2.00 or $5.00. Always put it just before them at an odd number. I don’t know how many times I have seen a company, currency or commodity falter just before a round number. Humans are wired to love them and amateur investors constantly make the mistake of placing their sell orders on these round numbers.
WHEN KEVIN SOLD WELL
Now I bring you to the secret of why I have averaged 65% through thick and thin each year in the markets for the last nine years. I have learned to buy well and to sit tight for several years. I have usually been able to sell well when they have matured. It took years to learn this formula and the tuition fees to get there were horrendous, but worth every penny.
In the last chapter I shared a story about the purchase process I went through for my current major stock holding. Now I want to go back to just before that purchase and give you the story of how I sold the previous major company I owned. I had originally bought 600,000 Silver Lake Resources (SLR) shares for 37 cents in 2009 and watched them move up in fits and spurts to around $2.55 in late 2010. There were three reasons why the price moved so well. Partly it was a rising tide of optimism that the worst was over from the global financial crisis which lifted all stocks from that very rare and severe plunge. In addition, the quantitative easing, which is money printing, that had been introduced to the world by the United States central bank had also put a huge tail wind behind the price of gold. Finally silver Lake itself had turned out to be the star of the Australian Junior resource sector. After this stellar rise the price then settled back down to the $2.00 mark. This was because the price had shot ahead of the increasingly good fundamentals for the company. This happens a lot so be aware of this phenomenon.
In my mind I was not even going to think about selling SLR until it reached $5.00 as I knew it would eventually reach this level given its rising production profile and the ever rising price of gold. As of this writing it has made it to $4.00 so my analysis is still valid. Anyway, by early 2011 the recovery out of the global financial crisis started to get a little long in the teeth. And by early March I could see global stock indexes all making a six month long rounded top which is the surest sign of a coming major decline. For those of you about to check the internet to have a look at this rounded top, the V in that top is the financial fallout from the Fukushima disaster in Japan. The stock market tide was turning and I had been caught to the tune of $1 million the last time it turned in 2007. For this reason I was emotionally skittish. I had learned the lesson that no matter how good a company is, when the tide starts dropping almost every company suffers. The sell decision is often fraught with mental tension and I was one of millions with fresh memories of what had happened just three years before. I was partially responding from fear and partially responding from logic.
In March I could see enough evidence coming through that the stimulus from the first round of quantitative easing had worn off and financial markets were going to go into decline. I made the decision to sell everything I had in SLR. I sold out in fits and spurts over a week into a stock price that was in decline. I could have sold at a healthier $2.15 but was always asking just a little more than what the market wanted. The process was very nerve racking as every cent represented thousands of dollars. I was chasing the market down. In a rising market you can put your sell offer in above the market, but in a falling market you have no choice but to sell at the price being offered so I left behind $50,000 compared to what I could have sold for. In classic fashion instead of looking at the difference between 37 cents and $2.00, I was looking at the difference between $2.15 and $2.00. In this bear market not even good news was giving the price a lift. In the long term I knew where this company would go, but my selling was all in the short term and emotionally I was a forced seller.
After I sold everything the price of SLR continued to slide as global stock prices did indeed stage a six month continuous decline, which accelerated when the US government started arguing over their debt ceiling. Although an outstanding company, SLR suffered along with all others. To every ones relief we did not see a repeat of the 2008 disaster unfold in the USA because the American monetary authorities announced quantitative easing number two in November and the politicians agreed to defer their argument over debt limits for a year. The SLR stock price halted at $1.60 three months after I sold out and then staged the mother of all rallies up to $3.70 within six months. Initially I congratulated myself for my astute selling at $2.00. I looked seriously at buying in around the $1.60 mark again but something inside me couldn’t do it. After purchasing at 37 cents to go in again at $1.60 seem like an unfair price. Emotion was trumping logic. I walked away from the company completely at this stage.
There are a few more lessons in this section on selling for a profit that I want you to take absorb before we talk about. These are random tips I have learned that will help you avoid the trap of being caught at the top:
First, once a stock price peaks and begins to decline it is twice as hard to sell because you feel like you’ve lost real money, even though you are still well ahead and any sale is still obviously at a profit. Giving up money that has already been created is psychologically more difficult than giving up money yet to be created. I recently heard of an investor who bought into the greatest capital appreciation story in Australian history, Poseidon Nickel. He bought early and rode it to the top. And then he rode it all the way down and still owned a lot of stock when it went into administration.
Second, never create a regret if you have sold at a profit, move on to the next fishing spot. If the price rises after you have sold, then you will often feel ripped off. You weren’t. You made a profit. If the price falls further you will feel great relief just as I did when the price dropped from eight cents to six cents. The lesson here is to stay as emotionally distanced from future prices as possible.
Third, never try to get the last 10% of a rally, leave it for a fool, take his money and run. This is so easy to say, but so hard to do. All the pleasure hits to your brain from the run-up in price have conditioned you to do more of the same, not the opposite.
Fourth, when a stock price makes you look like a hero, sell it. Sell when all the good news is in and it can’t get any better. Sell into upside exhaustion. When a stock price stops rising steeply, it never levels off calmly. It always falls off sharply.
Fifth, if the market has been running strongly and you know you need to sell out near a top then do the following: Sell “at market” if the peak has passed, and above market if it is still running strongly.
Finally, if a stock price moves 15% in a week it will usually be unsustainable. This is a sure sign a major top is coming and it is time to adjust your psychology. Most money is made by living off stupidity of the herd instinct of others. When the crowd arrives and then sell to them. If you follow this advice you will have the same legendry investment success of Dr Spock; you will live long and prosper
So there you have it, the anatomy of a major sale. There are many lessons here if you have a mind to find them.
GENERAL LESSONS IN SELLING
Fortunately I have not had to put my capital at risk to learn every lesson the stock market has taught me. The following ideas are points I have picked up along the way over the last decade and they are now more or less second nature.
As I have already hinted at, most companies in a sector float up and down together due to wider global or national issues weighing on the market. Some say over half of all price movement is unrelated to the individual company. So a decision to sell in order to buy a similar company could be a disaster because it will usually be done near a market top. I saw this happen in the Uranium sector in around 2005. The price of Uranium took off and all boats lifted, including the penny hopefuls. After the price peaked they all descended together. Only buy immediately back in if you are rotating out of the sector after a run up. If you want to stay in the sector, leave the next buy for a few months and wait for the emotional tide to go out of the sector. Time is usually required after a sale of stocks before smart purchases can be made. Selling after a profit is like a divorce. It takes time to work through your emotions. Buying on the rebound will substantially increase your chances of making a loss on the next purchase. When the sell decision has been made, walk away and don’t look at the market for a few weeks, at least until you have calmed right down.
One of the requirements of running a self-managed superannuation find is the requirement to record all buy and sell decisions. This has been an excellent discipline for me and I highly recommend it. The most productive way to face errors is to record all investment behaviour. We have an uncanny way of rationalising past behaviour in a way that makes us look better. Written records of why you made an investment will help keep you honest with yourself. The more you justify mistakes, the worse you will be as an investor. Written records help you avoid self-justification. Sometimes, like me you will read what you wrote when buying in and shake your head in shame.
Next, when good news comes through, stay calm. Excitement over good news could cloud your judgement, especially if there has been a steep run up into the announcement. Many people buy on a rumour as they have inside knowledge and then sell into the announcement. Never invest on good news. However, good news could give you the right timing to sell into a price spike. Only news that will have a lasting material effect on the company will re-rate the stock price. Most news will be either factored into the stock price already, or will be too small to be a game-changer. In 2011 one of my investments, Northern Star Resources, announced a drill intersection of 12,000 grams per tonne gold over one metre. This was one of the highest recorded in recent history in Australia. The price rocketed from 72 cents to 92 cents. But even this sensational news did not materially change the future of the company as it was only one drill hit. The gap created by this jump in price was eventually filled, as gaps usually are. If good news doesn’t move the market you have double the reasons to sell. The market as a whole may have turned already. The news was already anticipated or known by insiders and traded up waiting for smaller buyers to come in on the news.
You have now heard me talk about some very significant price runs in stock prices of companies I have owned. In my experience a typical growth company whose stocks grow at 15-25% a year usually has two or three runs of 10-30% during the course of the year. I do not try to trade these runs but if you are a shorter term trader you could profit from each of these runs if the discipline of buying and selling can be mastered. If you are trading these 10-30% fluctuations, always make sure the RSI and MACD are suggesting a bottom when buying and a top is near when you are selling. When selling make sure the RSI will be around 70 and the MACD will show a spike top. Or a lower top on a higher price as momentum fades.
It also takes rising volume to take the price higher. Volume is the market, all else is secondary. If the volume is way above its average, sell into it. The volume will eventually drop and so will the price. If volume has broken down, price breakdown can’t be far behind. The MACD indicator will show this visually as falling momentum, even when price is still rising slowly. When current volume levels reach those volumes which occurred at old tops, it could be time to sell. If prices have risen on low volume, beware of a false breakout. Volume displays the emotions of the market.
Along with everyone else, I attach significant meaning to my purchase price when monitoring my stocks. This awareness is a subtle, powerful and dangerous influence on the sale decision, especially if a loss has been incurred. Purchase price only ever matters to the market if a huge number of other investors came in at the same price as you did, which usually means a round number or significant volume spike. Sell decisions should never be based on cost price but on the latest behaviour of the market and charts.
Watching a stock do nothing for months at a time will get pretty boring. Be careful of the temptation to sell out because you are bored. Not surprisingly people often buy and sell stocks because of their felt need for excitement. Sales made out of boredom are usually made near slow-moving market bottoms or corrections. This is one of my weaknesses. When the information flow stops, and the stock price takes a six month breather, it can be so hard to stay committed as you watch your stocks grind out a cup and handle formation. Rationally it makes sense, but emotionally you need excitement, and it’s just not exciting. Alternatively, once a stock price peaks and begins to decline it is twice as hard to sell because you feel like you’ve lost real money, even though you are still well ahead and any sale is still obviously at a profit. Giving up money that has already been created is psychologically more difficult than giving up money yet to be created. It is always easy to sell at the bottom and hard to sell at the top; that’s human nature.
Once a profitable sale is made make sure you never regret what you have done. Your capital has increased so Move on to the next fishing spot. If the price of your stock rises after you have sold you will be tempted to experience an emotional downer. You made a profit and a profit is a profit is a profit. Learn this fact: You will never collect all of a price rise, ever. If the price falls further after you sell then you will feel great relief just as I did when the price of Cougar Metals dropped from eight cents to six cents. The lesson here is to stay as emotionally distanced from future prices as possible.
In relation to this point, never try to get the last 10% of a rally, leave it for a fool, take his money and run. This is so easy to say, but so hard to do. All the pleasure hits to your brain from the run-up in price have conditioned you to do more of the same, not the opposite. I recently heard of an investor who bought into the greatest capital appreciation story in Australian history, Poseidon Nickel. He bought early and rode it to the top. And then he rode it all the way down and still owned a lot of stock when it went into administration. It was the 1960’s, he had invested $15,000 and he could have sold at the top for over $8 million but it still wasn’t enough. So when a stock price makes you look like a hero, sell it. Sell when all the good news is in and it can’t get any better. Sell into upside exhaustion. When a stock price stops rising steeply, it never levels off calmly. It always falls off sharply. If the market has been running strongly and you know you need to sell out near a top then do the following: Use the “at market” tab on your sell order if the peak has passed. Sell above market if it is still running strongly.
Finally, if a stock price moves 15% in a week it will usually be unsustainable. This is a sure sign a major top is coming and it is time to adjust your psychology. Most money is made by living off stupidity of the herd instinct of others. When the crowd arrives and then sell to them. If you follow this advice you will have the same legendry investment success of Dr Spock; you will live long and prosper.
WHEN EGO HAS STRANGLED LOGIC
By now you should have well and truly picked up the message that you are your enemy. All your human instincts of greed and fear, conditioning and subconscious expectation of life come together around the mighty dollar. The love of money truly is the root of many evils. Sadly it is the biggest religion on the planet with more people worshipping money than any other god. In the next few paragraphs I would like to highlight a few of the signs to look for that show your ego has taken control of your logic when you are a stock owner. The stock market is a moody beast. It will either race ahead of a company’s valuations as collective greed takes hold, or fall below it as pessimism and fear strangle the throat of “Mr Market”. A booming market lifts most companies to the point that valuations surpass logic. This is collective greed, that most powerful of human emotions that pushes prices to these lofty levels. You will either profit from the collective greed of others or, more likely, you will be one of the greedy ones. Below are a few indicators to show you when you have entered into the greed phase of investing and should be looking to leave the party before you end up with a hangover.
Firstly, let’s talk about bragging, that confiding of investment successes to friends. Bragging is best left for others. The company lunch room or backyard barbeque is a great place to get the pulse on what is happening with people’s finances and is a tempting place to verbally show off. Don’t be bullish simply because you won a company. Be bullish because your analysis of the future gives you confidence. During the real estate and stock market booms of 2000-2008 the lunch room chat at my workplace naturally turned to house prices and stocks. Telling others about your stock profits in social settings makes it harder to take a loss. Once you declare something publicly, it is much harder for you to switch to the opposite view without feeling like a fool. By the way, this is one reason why people who get married have more stable relationships. Smugness and gloating should signal that you are buying an ego trip and using the stock market as your prides conduit. Always remember that around half of your paper profits will probably be the result of rising general market sentiment instead of your own skill. Men are especially prone to showing off and young men are the worst. Once you have lived through a decade of investing you will learn not to get emotional with paper gains or losses.
Spending increased time monitoring the market is another problem to guard against. I am guilty of this one. As markets rise I will watch the scoreboard a lot more than when my companies are in correction. It takes very little imagination for an investor to make the jump from fictitious paper profits to pretending they are real. Having to check prices several times a day during a strongly rising market is a sure sign you are out of balance and a top is probably near because everyone else is probably doing the same thing.
In our early days of investing, we kept celebrations down to a bottle of soft drink at dinner with the kids when we had made a profit in the markets. It is good to celebrate but keep them very low key. Larger celebrations excite the emotions and the goal of every investor is to stay as logical as possible at all times. Ostentatious celebrations by large numbers of investors are a dead giveaway that a market top is near. I can still remember walking through the Perth CBD, the world’s greatest beneficiary of the mining boom, on the last working day before Christmas 2007. I could hear wild corporate parties going off at every available venue from lunch until five o’clock and beyond. The “suits” had made a killing and were living it up. Looking back at that day with the wisdom of hindsight I can now tell you that contrary to what you have been told, they actually do ring a bell at the top of the market. It just makes the sound of a massive corporate revelry.
Counting your paper profits all the time is a sure sign of ego in control over logic. With today’s internet based trading, you can check your “score” every five minutes if you wanted to. When it makes you feel all warm and gooey watching your score go up, that’s the feeling of greed welling up inside. It is such a comforting emotion, but it is a false reality. Concentrate on those indicators that tell you what the future holds rather than the paper profits which tell you where you have come from.
Adding more money to a company after a large run up is a common error most of us have committed at least once. Adding to positions should only be done at the beginning of a rally after you have partially entered a market in fear and trepidation because you went against the crowd and caught the bottom or came in just after it. Adding money after two major legs up, when the media gets hold of the story, when your workmates start giving you investment tips, when interest rates start rising, when the charts start to flatten off, when indicators show the company and or the market is overbought, when you hear that lots of people are now borrowing to enter the market, or when the economic indicators start to flash red is not wise. It is actually time to consider partial exists. It never ceases to fascinate me that the best time to buy a stock is during thin volume at a low and the worst time to buy is when everyone is scrambling to get in near the top. Volume always seems to increase with price. I don’t mind as it makes it easier to get out when it is the best time to sell.
The big money is always made by being in early in the right company and then doing nothing for a few years! The great investor of the early part of the 20th Century, Jesse Livermore, one said that “anyone who is intelligent, conscientious, and willing to put in the necessary time can be successful on Wall Street. As long as they realise the stock market is a business like any other business, they have a good chance to prosper.”
CORPORATE REASONS TO SELL
At the end of the day you still may have done everything right with your investment decisions. You may have your ego under control and executed your strategies perfectly. Yet things can still go wrong because the people you trusted to run a company well have not contained the weaker side of their human nature. The leaders of a company are the very core reason a company does well. Good leaders can find grow any business. Bad leaders will always wreck a good business. Management are as fragile and as frail as the rest of us. In my experience there are some tell-tale signs to look for in weak management. I have listed here fourteen suspicious activities management can get up to which may help you know it is time to sell up.
1. Heavy promotion of the stock by management: A good company will sell itself. When management spend a lot of time promoting the company, they are wasting time that could be better spent in managing the company. Watch out for research reports that were paid for by the company. You will only know this if you read the fine print at the bottom.
2. Use of round numbers when making projections: This shows very clearly that management don’t know enough detail about what is going on in the levels of management below them. Good management will come out with very odd numbers when making predictions simply because they are precise.
3. Projections of unusually strong growth: Management would be better to give the market a lovely surprise with unusual growth results. Remember Murphy’s Law? If something can go wrong between the forecast and the end of the financial year, it usually will.
4. Management questioning the motives of reasonable doubters: Analysts, the media and brokers are paid to find the truth. If they are lining up against the company and management is attacking them, then it will be the management who is wrong 99% of the time. Stonewalling when trouble emerges is the first line of defence for successful, well heeled, proud corporate managers from the rich end of town. Workers who have moved up through the ranks to top management don’t usually have this problem. A classic example involves the board of the Australian Wheat Board who were bribing Saddam Husain’s government to get contracts. They denied it to all the Australian media and politicians for months and then it all unravelled in a big corporate mess. The truth always undoes the best of cover-ups.
5. Strong claims of being the best, unique, or exclusive in a business area: This happens a lot, especially if they are spruiking a new technology that is going to “take over the world”. Wait for new technology companies to prove themselves with a year’s worth of profit, not one or two quarters.
6. Defining the market narrowly so that they are the leader of their peers. If they really are the leader they will be paying lots of tax because they made lots of money. Let the books do the talking. This is often done by junior mining companies who will show you a chart of their peers that make them look good. More often than not half the companies they should have been comparing themselves to are missing.
7. Lateness in reporting earnings or dividends: This is a sign of a disorganised company or one that is fighting with their bankers or auditors. Delay is a death signal. Good companies can’t wait to get their results to market. Companies can fiddle their books in so many creative ways. A financial statement should always be read with a grain of salt and an eye on the tax paid. If they don’t pay tax and the books look like they made a profit, guess who will be chasing them within days!
8. Blaming outside forces when promises are not met: Imagine 100 creative excuses for a company not meeting targets and I will have seen at least half of them. It takes guts for a boss to take the blame for a bad result. They love their big salary and will defend it with whatever excuses they can find. In the lead-up to the Global Financial Crisis I had a large position in a company called Dragon Mountain Gold which had drilled out a one million ounce resource in China. I met the CEO while in Perth on a holiday and was struck by his frustration that the stock price was not reacting the way he wanted it to after he had “delivered” such a great result. I came away feeling uneasy. Sure enough, within months he was gone after the major stock holder had had enough of him blaming others for a lack of performance and burning through all the company capital.
9. Change of auditors: This usually means the auditors walked away from a crooked set of books they were not prepared to sign off on. It certainly does not mean the auditors were not good enough. No company would ever complain about poor auditors!
10. Change in lead banker with no improvement in interest rate: The only reason to change bankers is to get a better deal. If there is a shift in this area it probably means the bank was becoming a little uneasy about debt levels or debt servicing ability and walked away.
11. Insider selling: This is a big one. In some countries you can monitor the buying and selling of stock by management. Heavy selling volume after a good run, by chief financial officers or the CEO is a big signal of a future change of direction for the stock price. While other board members selling is not such a clear signal as they are not as close to the company books.
12. Resignation of key staff members for no apparent reason: This is another big indicator of division at the top, or near the top. This often happens when a new CEO with a big ego comes on board and throws his or her weight around with some grand new direction for the company.
13. Inconsistent management statements: I have seen management actually do this. They will come out with a great forecast, then back-track within a month or so.
14. Management that loves to spend money: Enron was a great example of this. The executive team had all the toys of the rich and famous; company jets, extravagant expense accounts, overseas trips and the works. They were consumers of wealth on producers of it.
WHEN THE CHARTS SCREAM “SELL”
As you now know, when the market rises, most company stock prices rise regardless of their sector or individual fundamentals. When it drops most will sink with it regardless of how well they are growing. In teaching you how to sell I have so far concentrated on looking at individual investors and companies for sell indicators. I am going to close out this discussion now with a few tips on how to tell when the “tide” is about to turn down for the market as a whole.
I was not experienced enough back in 2007 to see the signs of massive over-extension, mood change, and immanent decline in global stock markets. Actually that is not quite true. I could see them but refused to believe them as I had not lived through enough financial pain to respect them. Consequently my major investment in Dragon Mountain Gold peaked at $1.3 million that year and slowly drifted down over the next year to a point where I pulled the plug with a stunted capital base of just over $300,000. Believe me; ignoring international storm clouds is a lesson you only have to learn once. So I hope these selling tips will save you from some of the pain I have gone through.
A significant bull market is one that has been rising steadily and makes a series of higher tops and higher bottoms over several years. Just as time is needed for a rock thrown through the air to stop rising and begin to fall, so time is needed for a bull market to stop rising and grow old and tired. Flattening upward momentum creating a rounded top suggests a major correction is coming. When the bull is in this aged state he will not sire many strong offspring for you to buy at auction. If you see this shape in the longer term broad market charts then be on your guard for a failure to make a new high which leads to a sharp sell off immediately afterward that penetrates an old low. This signals that the market could no longer reach a new high and that the lows are now stronger than the highs.
Sometimes it is quite different. In the case of the dot.com bull market on the NASDAQ which peaked on March 10th 2000, a parabolic move upwards signalled the last hurrah. This is the opposite of the rounded top mentioned above. This last gasp of bull energy is more like watching fireworks go off. The media will be saturated with stock stories and everyone you talk to will know someone who is making serious money. After steep rises markets never plateau, they always plummet. After thirteen years the NASDAQ has never come close to the levels it reached back then.
The percentage of stocks making 52 week highs is the great measure of market breadth. Watch out for a declining number in the market breadth readings even though the headline index may still be rising. This means that a narrow group of the very largest companies are dragging the index up to its final high while the majority of companies have already begun their descent. Significant peaks in 52 week highs tend to occur six to twelve months ahead of a major market top. If a market is making over 5% new 52 week highs and over 5% new 52 week lows at the same time then the market is actually peaking. A serious decline will follow.
In the last two chapters I explained what a moving average was and to watch out for the 50 and 200 day moving averages. The key moving average sell signal to watch out for is faltering upside momentum in the 50 day MA and a flattening of the 200 day MA. The clincher that a bear market has begun is when the 50 day MA crosses from above the 200 day MA to beneath it. This will be some time after the market peak but it will confirm a major change of trend has occurred. These moving averages work best when a market is making a rounded top formation; they are too slow for use in a parabolic top.
If the RSI has a reading above 70 it is a very reliable indicator of a market that has reached a short-term overbought position and will correct very soon. The RSI is most useful when dealing with a fast moving market that is going parabolic such as what occurred in the Australian stock market in the year until November 2007 as it doubled from the year before. The more typical rounded market top is better seen through the lens of the moving averages.
Long term bull markets often have two legs of equal length and different angles. The first leg will be quite steep and seems to explode out of nowhere from an intractable long-term market decline. This leg may last for many months or a year or so. Then there is a wave of hesitation while everyone suddenly remembers the last bear market and starts to wonder whether the market is peaking. This pessimism is needed to rebalance an over extended market that got ahead of the fundamentals. Then the second leg begins but this time the angle is flatter. The point of interest to you as a potential seller is when the market is approaching the end of this second major leg of a bull market and flattens right out. To see these major legs in a market you will have to step back from the day to day noise and look at three or five year charts.
In conjunction with the second and less confident leg of a bull market, there often appears the dreaded rising wedge formation. This is a pattern of shallower highs with steeper rising lows under them in the six month trading range. This pattern is telling you that buyers are still aggressively pitching in their capital, but the number of sellers is increasing so the top of the price range is flattening. A rising wedge formation is particularly ominous if it has developed on diminishing volume. The flattened top indicates sellers more eager to dump stocks. Dump yours with them.
Another strong pattern that indicates a major tip is forming is the head and shoulders formation. Look for this formation to develop over several months and check to see that the right shoulder is lower and has developed on declining volume.
A double or triple top are price patterns that simply shows a market coming up to a major resistance level two or three times and is unable to penetrate that top. If these occur toward the end of a multi-year cyclical bull move it will probably fail and move into decline very quickly. The American stock market developed a triple top from its price action from 2000 to 2012. This suggests rough years ahead as it continues to grind sideways in its secular bear market in order to get the average PE ratio down. Be careful with triple tops in a market that has a history of rising over several years but is now in a consolidation phase just under the tops. You will see this clearly because the lower price range will creep up while the tops are flat. This suggests buyers are becoming more aggressive. Once the resistance level is broken there usually follows a very rapid ascent because few sellers are left. Have a look at the global gold chart from 2010 to 2013 to see this pattern in action.
For short-term traders it is wise to note that after the general market has advanced around 20 percent over an average of 90 days, which is a 13 week cycle, people become weary of paying the higher prices and there will be a significant pullback. Markets average around 10% a year in cash and dividends in a healthy growing economy over the long term. So a rapid rise in a short time is clearly unsustainable. Use all the other indicators mentioned in this list to verify what you suspect is an unsustainable rise.
Unbridled optimism is another hallmark of a market top. When the online chatter and the idiotic main stream media are all singing the same tune of how wonderful the world is, begin worrying. If it can’t get any better, then it will not! After the stock markets have been rallying for a long time in a strong up-leg, there will be nothing but great news and rosy optimism all around you. This is one of the surest signs of a top just as the markets are topping. Listen to the optimism and do the opposite of the crowd.
There are many other methods of finding out when a stock market is peaking but these are the main ones and are all you need to know about so as to make intelligent decisions. The biggest problem will not be the evidence and indicators. It will always be your ego. The human will drives everything that makes human and it is a stubborn beast. When you have been experiencing multiple pleasure hits to your nervous system you will not part willingly or easily from that source of pleasure. To sell well at a major top you must let go of the sense of pleasure you have been experiencing and begin to picture in your mind the financial pain you will experience if you do not sell. This visualisation is the only way you will come to achieve any form of objective decision making at a top. All the best.
|What is the market index since purchase, totals and percentage?|
|What is the sale price and % move since purchase?|
|Did the purchase rationale prove correct?|
|If not, when did failure become apparent?|
|How long was the time between failure and sale?|
|How much did the price move in this time period?|
|Were the stocks held for longer, or shorter than expected?|
|What was the highest price for the stocks while held compared to sale price?|
|What was the low price of the stocks while held?|
|Did the stocks go above the sale target while held?|
|If so, then why weren’t they sold?|
|Was a stop loss, mental or otherwise ever made and broken?|
|Was the sale planned or impulsive?|
|Whose idea was the sale?|
|Were the stocks sold into strength or weakness?|
|Was the sale price set or at market?|
|Was the RSI in overbought territory when the stocks were sold?|
|Was the sale made into a volume/price spike?|
|Was there a run up before a good news announcement?|