THE ART OF SELLING STOCKS

 

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There are, broadly, two types of sales. The first one is a specific stock sale and the second one is a sell on the market. The contents of this post should not be construed to mean I am suggesting a sell on the market. Yes, some stocks in my opinion are worthy of being sold. Which ones? Maybe you can use the contents of this post to find out more about that.

 

Selling Is an Art, Why?

 

• It has been historically proved that even the best of fund managers, who are good at buying stocks, are terrible at selling them. This is one of the main reasons why most funds fail to beat the market. What makes a selling decision so difficult? Basically two reasons, selling to book a loss means admitting a mistake, which most of us find difficult to do. Selling to book profits is tempting and leads one to exit too early. Is it better to sell early than sell late? The jury is out on that.

• This advice to investors comes straight from Charles D. Ellis’s seminal book: Winning The Loser’s Game : Timeless Strategies for Successful Investing

“Individual investors , as we know, usually buy for reasons outside the stock market: They buy because they inherit money, get a bonus, sell a house, or, any other happy reason, have money to invest as a result of something that has no direct connection to the stock market. Similarly, they sell stocks because a child is going off to college or they have decided to buy a home-almost for reasons outside the stock market. Candidly, when investors act for reasons they think are inside the market they are usually making a mistake; they are not in the center of the action, where the professionals and the expert analysts who serve them are making important decisions. They are either optimistic and late because the market has been rising or pessimistic and late during a falling market”

 

How to sell?

 

We all need to create a framework and discipline for selling securities. It is also a subject which does not get the attention it deserves. There are so many books written on how to buy stocks, but very few on how to sell them. Many investors refer to a lot of data before they buy securities. However, little research is done before selling them. This is despite the fact that selling forms an integral part of the trading process. I have listed a couple of ‘selling techniques’ below. They are based on my own trading experiences, and the countless newsletters of market ‘gurus’ which I have read.

1. As soon as you realize that you have made a mistake.

This sounds the easiest, but in fact is the most difficult to put in to practice. Most of us find it very difficult to admit a mistake. This makes selling under/non performing stocks a bold decision.  There is not much difficulty in making  sell decisions when events impose themselves on you. It is best to act before any such thing happens. The important lesson to be learnt from these ‘mistakes’,  is to move forward immediately : when you find yourself in a hole stop digging.

 2. Getting tomorrow’s price today.

This is commonly referred to as ‘stocks which have run ahead of their valuations’. In the current scenario, the mid and small cap stocks have run up substantially. This is a tricky situation, why? It is very difficult to form an opinion as to whether fundamentals will catch up with the current valuations. Only time will tell. An example, is that of Abbott Laboratories, which closed at Rs. 2855.70 on 10th Sep, 2014 and at Rs. 3339.45 on 12th Sep, 2014. This, 20 % jump,  was apparently, was due to the fact that the honourable Prime Minister has a luncheon meeting with the head honcho of Abbott Laboratories during  his forthcoming U.S. visit. A 20 % jump in stock price, just because of this reason, is as absurd as it can get. In case there is any other trigger, I do not know of it. (I do not hold Abbott, so the question of bias does not arise). There are plenty of stocks moving on similar sounding justifications.

3. Using a stop-loss.

This is used by many day traders. Actually, it has got greater application in a delivery based trade. In a day trade, stop losses only have the effect of increasing client turnover. This is self-defeating. Most investors have a target price for stocks which they buy for delivery. Hence, whenever one buys for delivery, it is best to put a mental stop-loss of 10 % below the purchase price and ruthlessly execute it. I think this is the best way of selling losers and ensuring capital protection. The 10 % limit is not sacrosanct, it can be adjusted to suit oneself. Ideally the percentage should be lower for high-priced stocks, and higher for low-priced stocks.

 3. Re-balancing.

Re-balancing a portfolio should be focussed on big winners, which have grown to be a large percentage of the portfolio, due to their out performance. Re-balancing is, in effect, an acknowledgement that the future is uncertain. Hence, it is better to diversify in order to manage the risk of the unknown. It enables an investor to hold a scrip for a longer duration. This has the indirect effect of maximizing profitability of winning positions, which might otherwise get liquidated in the event of a market downturn. If one takes some money off the table, the risk of an over-sized position is mitigated to a great extent.

4. Change in sector outlook.

When the company’s sector outlook is changing. This is especially true of companies which are dependent on technology. Due to obsolescence, many a time the future outlook gets blurred.  If one feels that there is a fundamental change in the company’s business or outlook, it is better to sell and get out. A classic example is Eastman Kodak which went into liquidation after the advent of smart phone cameras. They just did not adapt, what was once a blue chip is now in the doldrums. Another one is Xerox Corporation which is also facing the heat due to email and the attendant scanning technology. A change in outlook for a stock or industry should not be ignored, and must be acted upon at the earliest.

5. Under Performance.

One should also sell under performing stocks, those which do not participate in the broad up move by the market. The converse is also true. However, this has to be tempered according to the sectoral rotations which we see so often. If a stock fails to respond to good news it is a sure sell signal, stocks moving up on bad news are a buy.

6. The Growth v/s Value debate.

The combination of high valuations along with extreme positive sentiment is one of the best times to sell stocks.  This, however,  is very subjective. If one person thinks stocks are overpriced another person may not. In the current scenario, the valuation of some of the ‘growth’ stocks is so expensive, that I personally do not feel that they can add to any ‘growth’ in an investor’s portfolio. A switch from such stocks to ‘value’ propositions seems appropriate. The current momentum in the mid and small cap segment cannot go on forever!!

Conclusion

 

• There are many other methods for selling stocks. These are, however, based on valuation methodology, which is difficult to decipher for most of us. We generally tend to find out after the play is over i.e. we are too late. The plethora of ‘research’ reports which are easily available, almost never advocate a ‘sell’. A ‘sell’ call is disguised in two ways viz. ‘Under-perform’ or ‘Market Perform’ . I have always wondered why they are not explicit. In the rare instances of an explicit ‘sell’ call, you can be sure that nine times out of ten, it will be too late to be of any use to anybody.

• Actually people have a habit of tracking the price of stocks they sell. There is a desire that after they sell, the stock should crash. It just cannot move up. I too am a guilty of this. In my business, I often tell my clients to stop worrying about it, why? Well, in a lighter vein, it is like worrying about who your wife sleeps with, after you have divorced her!! That should not matter actually, but then people (me included) are married to their stocks.

• My own experience with selling has been pretty disastrous. Many a time, stocks which I buy, sit idle for months. No sooner do I sell them, these lifeless and ugly   stocks, suddenly change their frog like appearance to that of a prince!!