Back on May 22nd I put up a posting on timing the perfect entry into a stock:
In that piece I offered up the opinion that, with all the tools at the disposal of the big players, that even if a retail investor times things perfectly, that he/she might still see a stock drop after buying in. Sometimes its not just a question of timing the market, but of ''time in'' the market.
If entering is the yin then exiting a stock is the yang. And as hard as it is to pull the trigger and buy, I believe selling is even more difficult. Especially if you've done well in buying near the lows, and have made big gains.
I want to be perfectly clear here about one point. In this posting I am referring strictly to speculative stocks. I'm talking about companies that are NOT paying dividends, companies that have NOT achieved profitability. I am referring to companies that have survived and are surviving by selling their stock.
This is contrarian investing at its core. A contrarian buy involves making a purchase when things look bad, or when things are extremely quiet with thin volumes being the norm. In other words, buying low. A contrarian sell on the other hand involves unloading when the news is good, when there's lots of excitement and when volumes are robust. Selling high in other words.
Why do I consider buying low easier than selling high? Human nature.
Buying is easy when compared to selling, even when you're buying a stock that is depressed, one that is either out of favor or below the radar. The reason is simple enough, its because of the belief that the price will climb. For a contrarian, seeing Fear, Uncertainty and Doubt (FUD) is a good thing and it triggers greed. It should naturally spur some research, which in my case includes an analysis of the chart. But once the decision to buy is made, its just a matter of making an entry.
However selling can be incredibly difficult, and to demonstrate why I will use an example, employing my favorite hypothetical stock ABC.
ABC Industries is a quiet little company, with its stock ABC trading for $1 with volumes typically less than 100,000, although there are occasional bigger volume days that get up in and around 1 million. You look at the chart and form a bullish opinion, and the industry that ABC is involved in, you think it could become hot.
You pick up 1,000 shares, a small position, thinking yourself lucky because you got in for $1. In a week or two its traded down as low as 90 cents, and you kick yourself for not being more patient. But then it starts to move, back to $1 and then to $1.50...and then in a couple months its up around $3. You note that the volume is still thin, occasionally getting up around 1 to 2 million, but there's over 100 million shares outstanding so you hold tight.
Then things really heat up. ABC starts flying, its been mentioned on a popular web cast, there's lots of news coming out on the company, newsletters and analyst recommendations making the rounds. The PPS is up around $7 now, with price targets of $15 being put out by experts.
Things keep heating up, when it hits $10 you think maybe you should sell, but it settles there and finds support, so you hang on. Then more excitement comes, the company makes a big announcement, they've signed a deal with another company that is projected to mean huge sales. The PPS responds and climbs to $13 a share and you start to think that the $15 target put out by the investment bank analyst might be seriously low.
$13 a share, you've turned $1,000 into $13,000 and now you regret not having bought more.
Then something happens, the PPS starts falling, dropping all the way back to $11 in just a couple days. Your $13,000 has turned into $11,000. Its still an incredible gain for an initial investment of $1,000, but its not $13,000. You resolve that when it gets back over $12 you will sell. But instead of rebounding it falls further, in another few days its under $10.....You've forgotten that at $10 per share you've made $9,000 in profit, instead you're thinking of the $4,000 you ''lost'' by not selling the top.
And so it goes.....
While greed keeps retailers holding the bag even after they've made big gains there are other reasons too. Retail investors are known to fall in love with their stocks, even those that are 100% speculative, relying on share based capital to finance operations and to meet payroll. Every company press release and filing has been read as well as all the transcripts from conference calls. Interviews have been pored over, and you may even check out stock sites to garner a sense of the overall mood. Anyone who is down on your darling stock on a social media message board is exposed as ignorant, a short seller, or both.
So what's the bottom line?
You've likely come across someone who has lost money on a stock, and who has expressed that common refrain: ''Its not a loss unless I sell''. The rationale is that eventually the stock in question will recover and that the losses will disappear at some point and possibly turn into profit. There is merit to that point of view, but with speculative stocks if you get roped in on a lot of hype....then you could be looking at a reverse split and even bigger losses later.
Well, just as a loss isn't a loss until you sell....likewise a gain isn't a gain until you sell. One is called a paper loss, the other a paper gain. Until you crystallize a gain by selling you're dealing with paper gains and paper can be very fragile.
Some will bemoan selling because of income tax considerations. I can only comment on Canada's tax laws, I don't know what the rules are in the U.S. In Canada the capital gains exclusion rate is 50%. What that means is that 50% of a capital gain is tax free. So using a $10,000 capital gain as an example, $5,000 of the gain is tax free, go on vacation to Mexico or pay off your credit card (I would strongly recommend the latter). The remaining $5,000 has to be declared as income and will be taxed at your marginal rate. If that rate is around 20% you will need to keep $1,000 back for tax purposes, if your rate is 40% then its $2,000. Still some nice Do Ré Mi in your pocket.
Everything goes back to one of my late great father's favorite bromides: You'll never go broke taking profits. Another I like is attributed to numerous people like JP Getty, the story goes that when asked how he got so rich the multi-millionaire replies: ''I always got out too soon''.
The name of this blog is Avoid The Bag, on reflection I think another good name would have been Escape The Bag. After all, as a retail long investor to make money on any stock you first have to buy it, in other words you have to hold the bag. Hopefully you will escape the bag, and take some extra cash with you when you go, that's called winning the game in my books.
And if the stock you just sold keeps climbing? Oh well....that means those who bought the shares you sold now have the chance at gains themselves, if they sell.
Again, please note....this post was specific to speculative stocks, companies that have not achieved positive earnings. If you are absolutely convinced that the big gains you've made are in a company that is going to be the next Microsoft or Amazon, then I wish you luck and hope it works out. Those are the exceptions to the rule, but on rare occasions they do happen.
Good luck.
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