When to Sell – Part One

I’ve been spending some time digging around in my trade journal and trying to understand this. Getting a handle of this very important aspect of investing is one of my birthday resolutions. This study and therefore these series of posts are a set of steps in that direction. I’ve entered into 337 sell transactions till date. The first time I ever booked a profit on a secondary market trade was way back in 05Oct’01 and the latest one was as near as 06Sep’10. To understand more about the when of my selling behaviour I looked at these 337 in conjunction with the market and it’s valuation. I also tried to plot my sales in along time to see if there were clusters of sales happening during particular time periods. I will bother (and write) about the other questions of why, how and what regarding my selling behaviour at a later stage.

For now, I constructed this chart which shows my selling activity during the period spanning Oct’01 to Sep’10. The small green histograms at the bottom show the distribution of my sell trades. Three clusters seem to emerge: Aug’04 to May’05; Jan’07 to Apr’07 and Aug’09 till date. I have started my investing career with a handicap – which might seem like a paradox given the upward ascent of the NIFTY since 2001. What I mean is that my investing thought process has been spawned during a whopper of a bull run. Nearly anything anyone touched during 2001-03 turned to gold. Midases were everywhere, hemlines were getting higher by the minute. Then after that 2008 and the early part of 2009 was such a humbling moment. And a great learning experience. I lost money on a few trades and the flurry of sales that you see during more recent times are my unwinding of those doomed trades as they recouped some of their lost ground. The wicked blue line represents the market – NIFTY in this case. The oscillating orange band represents the value of the market – trailing 12 month NIFTY P/E ratios. If one uses this lens to view the art of getting off the train, then it’s good to be a net seller when the NIFTY’s P/E is above 25. It pays to be a net buyer if the NIFTY P/E is below the first quartile (under or at 15). Currently the NIFTY P/E is around 24 so we are entering hilly terrain – best to tighten up our seat belts. I use the terms “net seller” and “net buyer” since even at exalted heights of market valuation one can find a few lonely bulls rampaging around and likewise the depths of market penury still throw up some bears lying in wait to maul you.

The idea is that statistics and data tell a story about your trading pattern. It is useful to step out of the frame once in a while and see things from a wider time perspective. I guess successful traders need to necessarily have oodles of experience behind them. The best minds in the business have lived through at least a couple of downturns and figured out their behavioural patterns and emotional compass. Also, when you see the picture in cinemascope, a few down months don’t seem all that frightening.

The wise ‘old’ men of investing mysteriously say – buy when you see value and sell when your asset gets expensive. but how the heck does one go about ‘seeing value’? We seem to know/have heard about things like fundamental analysis, discounted cash flows, industry compares, etc. Most of us however, do not have the time to do detailed down-to-the bone analysis of company financials. Some of us don’t even know how to go about doing it. I don’t think that such people should not participate in the markets or run scared of balance sheets and mathematics. I guess what is required for this set (I may fall in this realm) is to develop and consistently use common sensical heuristics with modest return expectations. One such rule is getting in and out depending on the movement of NIFTY P/E as compared to the two control limits as depicted in the chart. You may have a better method – gazing at tea leaves perhaps – whatever it is, I think the key is to stick to it. Economies and therfore the stock markets have a slight inbuilt bias towards expansion and growth. Therefore, the dice is loaded – but only if you stick to the same dice.

I don’t drink tea, BTW.

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Stop Losses

Many investors err when they end up throwing good money after bad. The temptation to average the costs down has weighed down on most of us. The problem with this tactic is that it works only when you have studied the underlying asset very very thoroughly. Most of us do not do this. Most of us are not equipped to do this. Most of us do not have the time nor the patience to do this. The other mistake that many investors make is that they get into a position without having pre-decided their stop losses. Or ignoring the stop losses when confronted with a losing proposition.

Almost all of us would have had someone in our extended family or friend circle who might have been badly mauled by the markets and would have consequently vowed never to return. It’s not their trades or the risky nature of the markets that did them in. It’s their lack of discipline. So many times we hear the refrain that markets are too risky. Actually, the market is not risky at all – it is the behaviour of the investor that is risky. The market never induces you to buy. This weekend when I was in Bombay, my mother told me about the losses that my father had totted up during his investing misadventures. Luckily for us (my brother & I) he did not sell off his losses, he just ignored them. And these shares (most of them cyclicals) passed on to us after his demise. And wow! The cycle turned in 2002/03 and how! Imagine riding Steel Authority of India Limited from 6 to42 in a period of 18 months. That hooked me for life. Till the losses tested me.

It does not matter when you buy, it’s when you sell that’s most important. This post is one amongst the various efforts on my part to understand the full meaning of this sentence as per my 5Aug resolution. One can get out of a position making a profit or else leave the table with a loss. Stop losses are signposts that help you decide when to sell if your trade does not work out the way you intended it to be. There’s no emotion involved, just hard nosed, dispassionate, stoic discipline. Statistically, mostly men/boys invest – so much so that investing might seem like a male thing to do. But successful investing is really quite machinistic and dull. Stick to one trading system, do not flip in and out. Stick to your stop losses. Write down/visualise your goals for each position. Maintain a trading journal recording your behaviour and why you did what you did kind of thing. Boring. Please read this cool article which talks about the 5 uncommon rules of the really wealthy traders to get some sense of how boring trading can get! Putting money in a bank fixed deposit or better still a ULIP can be so exciting! You’d get all the time in the world to party.

Sometime back I saw the movie Kites. Kabir Bedi, a powerful casino owner plays the father of Nick Brown who tells this to his revenge driven son when the woman whom he was to marry elopes with Hrithik Roshan:

“The true gambler is the one who knows when to get up from the table”

The other anecdote that comes to mind is from a job interview that I had conducted for a senior position in my company some time back. The candidate was trading on the prop account of some agency and among other questions I had asked him about his trading style and attitude towards stop losses. The guy said that he had never ever violated his stops. The two people who reported in to him had busted their stops one time each. I don’t care if this was just for the effect but inspiration strikes from the most unlikely of places. I have read quite a few books on trading, psychology of trading but when I met this “pretending to be in control” guy I thought that if this chap can do it, why can’t I. I’ve respected my stops ever since – hopefully it will become a habit.

This is important since stop losses can protect you even if you suddenly get whiplashed by a sharp correction. In fact its quite cool since you will quickly be in cash and hopefully will be able to redeploy and make more than what the stops cost you. Which brings me to important question: What should the ideal stop loss be?

The quantum of stop loss depends on what you expect from your investments and who you are. If you trade in and out intra-day (the post is not meant to be read by such people anyways) then your stop loss levels will obviously be extremely tight. Maybe 1% – 2%? There’s a lot of material on discussion forums and websites which points out to 2% being a good rule of thumb. But I feel that if one trades for longer periods, across multiple settlement periods a level of 5% is good enough. The volatility in Indian stocks is high enough to justify a 5% stop loss level. This point is important since if you are an infrequent trader then there is a danger of getting whipsawed if you put too tight a stop. Putting too tight a stop is like writing an annuity cheque to your broker. Your choice of stop loss ideally should be predicated by:

  • your risk appetite
  • risk in each individual position
  • volatility of the position
  • the amount of capital locked into the position
  • market conditions – if you want to go long in a bearish market, it’s absolutely essential to impose tighter stops.
  • time frame for the trade (discussed above)
  • Bravado (best if this reason be read and forgotten)

 Mental stops do not work. Period. I have done some conditional formatting and alerts on my trading spreadsheet and the annoying things keep popping up reminding me to cut my losses and run. You could have your own custom system, more sophisticated than mine, but do not do it only in the mind. It’s easy to overrule one’s mind.

This piece is obvisouly written for people like me. Casual traders. Folks that have a day job and who can afford to look at stock prices only a couple of times a week when the market is on and perhaps 3 – 4 times a week at night while the market sleeps. Folks who want to flog their investible surplus for some alpha instead of letting it rot in bank deposits. The Anirudh Sethi Report, which incidentally became the first site to link to my website has a cool example of how stop losses can be used to make money a la big game shooting. The lesson is almost like a Zen Koan. In fact, Zen masters would make awesome traders.

Another Year, Another Story

Just completed yet another revolution around the Sun today at 4:15 PM precisely. 35 full circles! 35 laps done and no pit stop yet. No sign of the chequered flag either. And yet my head is not spinning. I look the Sun straight in the eye, since He is my ruling planet. In fact, it was quite a good omen for the Sun to have burst into flames 4 days back and sent in a massive shower towards Earth.

Moving from astronomy to astrology, this is a rare moment in time when this day for me appears to be so close to a new moon. It will only be after a couple of decades that I will be able to experience this rare alingment again. Gulp! Astrology and I? I hate to admit it but I can be quite wussy sometimes!

Multiples of 5 are spooky milestones. It’s like completing a level in some video game – you feel a sense of accomplishment while bracing yourself knowing that you’ll be meeting more ogres, evil vamps and monsters in the next level. I’m going crazy thinking that the next level will take me to 40! Fuck. How embarassing. In a dastardly attempt towards self delusion, I mailed myself this birthday greeting card! I was elated when it came through. 🙂

The best gift definitely came in  the form of news that my daughter has moved up from the city round and made it to the state round of a spelling bee competition.

Finally, to brace myself for the oncoming mutants, zombies, aliens, et al, I guess I will have to do some (if not all) of the following:

 

– Gift myself more time. This is damn easy for a lion! I put a mental tick here even before I finished typing this sentence.

– Get trimmer and fitter. Health according to me is not wealth, but is important nevertheless. I seem to have neglected myself in the past year and the effect is showing. 🙂 I have joked many times that my weight always increases faster than my salary. But now I am serious. The new order of the rates of change is: Inflation > My weight > My salary. The future order should be My Salary > Inflation > My weight

Btw, there is a trick that most fashion/film photographers employ when shooting guys – ask the subject to stand akimbo and twist his torso 30 – 45 degrees. Take the shot from the side. Voila! You get a perfect V. Vain guy readers, try it the next time you negotiate your bathroom mirror. If you are a perfectionist then place your fist – the one which is on the camera’s right – near your trouser pocket as if poised to remove your car keys or something. Tightly spasm your other arm as if paralysed and you’re done. Just dont grimace the way John Abraham did when he was trying to hold up his beach shorts. But I digress. In my next post I will be talking a lot more about the male body, so hold on to your beach shorts till then.

– In the past, most privileged years of my being around, I have largely taken, taken, taken from the environment. Maybe I should start thinking about giving for a change. To myself 🙂

– Figure out the answer to the question about investing that has always vexed me. By the time I come back around to complete yet another revolution around the Sun, I hope to be in a better position to know when to sell!

– Pay more attention to sonny boy. Had sat down and taught and read books with the daughter a lot but could not do so with the brat since work had exploded around the time he burst onto the scene. Thankfully, he is picking up things on his own from his sis, so I’ve sheepishly escaped! There is a pending project with him re “traffic lights” – a small scale model of a city, with roads, houses, traffic lights, petrol pumps and lots of lots of cars plying the roads – that I was to do with him last year. Hope to do it this year. Will post pics if anyone cares to watch, but won’t use Lego bricks since so many Lego bricks will turn out to be expensive. We’ll do Thermocol.

Read at least 12 books this year. Books that are unrelated to my profession. I rarely read fiction these days.

Do not read Atlas Shrugged this year! Have read it 5 – 6 times already and I think that has been one of my problems. 🙂

Stop idolising Jesse Livermore.

– Target to increase the monthly views to The Third I by 30% by end of my next turn around the Sun.

Stop paying people money to visit my website! There, I said it. Beware, some of you readers – the taxman cometh.

360 degrees to cover. 10 commandments to live by.

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