Saturday, November 04, 2006

The Selling Process Part 4 4 comments

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Looking through the topics I have discussed, the selling process is the one with the most parts to it (Part 1, Part 2 and Part 3), together with Investing Philosophy. To me, selling is probably the most important in the three-step process Buy-Hold-Sell; especially for me, because I recognise that my personality conditions me to be able to buy with confidence, hold with patience but unable to sell with grace. I suspect that many people face this problem too. That is why I have to constantly remind myself of reasons why I should not sell, while assiduously searching for reasons why I should.

It may shock some fundamentalists but one of the factors that I look at nowadays when considering reasons for selling a stock is the price trend. As Warren Buffett goes: when the price of the stock goes down, it should become more attractive and one should buy more.

Provided, of course, that the caveat, that the fundamentals of the underlying business haven't changed, is true. Many people miss out this proviso of Buffett's statement. The tendency to view a stock with rose-tinted lenses when one holds it in his portfolio is all-too-human, to the extent that one can be prone to intellectualisation (ie. finding reasons not to sell) in the face of a steadily falling stock price.

Yet, investing is all about dichotomies. A high PE can mean dangerous valuation or an indication of a strong defensible business model; portfolio diversification can be good or bad since it means reduced returns but also reduced risk (though for academicians it seems to be unaffected return and reduced unsystematic risk); raising of interest rates can be good or bad because it respectively signifies a booming economy (which leads to rising inflation that must be controlled) and a crimping of liquidity which will squeeze asset prices. So it is with falling stock prices: it can either mean the stock is a better buy than before because of an improvement in the relative valuation/fundamentals ratio, or it can hint at non-public information that the fundamentals have declined, which has driven down stock prices. So which is driving which? That is the chicken-and-egg problem which has no easy solution.

Actually if one think about it, considering stock price as one of the factors in one's selling decision is not illogical at all. After all, firstly, the stock price is what determines our gains/losses. How can it not be a factor? Secondly, it rises and falls according to the fortunes of the business --- long-term. How certain is one about how far the long-term is? It could be now, and the price is factoring in the declining fundamentals right now. Thirdly --- and this is one for the academicians --- stock price volatility is how they determine beta, the market risk of a particular stock. Supposing that near-term price becomes volatile, surely that means the near-term risk has increased? (In fact, I may go one step further and qualitatively claim that beta as a measure of market risk should be weighted more towards near-term price volatility rather than over the long-term ie. near-term price volatility should be more important). Fourthly, isn't the old adages "never catch a falling knife" and "buy on the way up" examples of correlating the buy/sell process with price trends? People don't seem to have trouble following that.

Obviously, deciding whether to sell when stock price declines is a case of judgment. If I can suggest some factors that will influence it, they are as follows:
- Blue-chip or small-cap (the former has a greater assurance of business fundamentals, hence are more likely to rebound)
- One's degree of confidence in his understanding of the company's business
- Opportunity costs (maybe it's a chance to exit and buy into that stock you've been eyeing in your watchlist all along?)
- The risks. The risk aspect of a stock is always underestimated because the general tendency is to look at the upside. Instead, risks should be what's important to understand when the price is falling, because they are likely to be the ones causing the decline
- The weightage of the stock in question in one's portfolio. It's a case of managing your risk exposure.
- Technical factors eg. selling on high or low volume? Support levels broken?

It is indeed walking a tightrope, because making such sell decisions is a process of balancing the two parts of the dichotomy of the meaning of price action. For me, I myself had a recent episode where I was faced with a 10% decline in the price of a stock I was heavily into. It was a decline on above-average volume. Considering the fundamental risk factors and the fact that there was no clear reason for its decline --- the greatest danger, because there is no way to quantify any potential downside --- I decided to dispose of part of it although initially I had bought into it on high hopes of it being a multi-bagger (I shall not reveal the name here lest I am accused of pushing stocks). Frankly, it is as much a process of thought clarification as well as risk management. I have found that it aids one in being more objective in his thought processes surrounding the stock once he sells part of it. It helped, of course, that I had several other targets and considered opportunity costs of waiting for price stabilisation to be too high.




Blogger gsg said...

Thank you for sharing another good piece of article.....always feel the subject matters are very close at heart to me whenever I read yr postings. If you ever consider putting your thoughts into a book, please reserve 100 piece for me, I think it will be a great gift to my clients.....good weekend

11/04/2006 9:49 PM  
Blogger DanielXX said...

Into a book? That's a new thought. :-) Maybe one day, when I have made enough from my investments that people will be willing to pay to read about my philosophies haha.

11/06/2006 9:16 PM  
Anonymous Anonymous said...

Baring a fixed percentage cut loss rule, I feel that price should only be a determining factor for selling if one buys based on technicals. If one buys based on fundatmentals, price should not be a factor.

In your article, you have mentioned a few dichotomies. Maybe buying based on FA and selling based on price or TA is one of the dichotomies, especially if one is projecting a subjective high probability that price can inform you on the future earnings of the stock.

In the long run, stock prices will always follow the underlying business' results. And of course, one can feel one's stupidity in the short run if price plummets when one tries to capture the long run positive return.

11/07/2006 8:10 AM  

Theirs no certain time to sell a stock you just have to trust your judgement.

1/03/2013 1:24 PM  

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