Share buy or sell: What to do?
Friday, 20 May 2011
AM Mainuddin Khan
Stock trading is now very much a burning issue in Bangladesh. Last few months many investors lost their money in the share trading business. Most of the share investors are still not aware about the strategies of the business as they are driven by rumor. But there is no alternative to knowledge and education regarding sustainable stock business. With this view, I am highlighting a few important strategies for the share trading business. The decision to sell a stock should be similar to the decision to buy a stock. But the price paid for a stock must be put aside when deciding if it is time to sell. The sell decision should focus on a company's future prospects and fundamentals relative to its current stock price. If the reasons for buying the company-i.e., its fundamentals-have not changed, then there may be no reason to sell. Many investors lose sight of this and allow their emotions to dictate their sell decisions. In investing, there are a few universal truths. One of them is that at some point, a stock's price will fall. There are myriad of reasons why a stock's price falls and it is up to you to determine the cause. By identifying why the price is falling, you are far better equipped to decide if it is time to sell your position or if the fall in value presents an opportunity to purchase additional shares. The key is neither to react every time a stock you own dips, nor to become so emotionally attached to an investment that you stay with it no matter what the news. Weakness in the overall market, by itself, is never a good reason to sell your stocks. Share markets rise and fall, but history has shown that over the long term a well-diversified portfolio of stocks will not only generate a positive return, but also provide the best opportunity for providing a return above the rate of inflation. It is important to keep your investment horizon in mind-long-term investors should not be deterred by short-term declines. It is a good idea, however, to compare the performance of an individual stock to that of the overall market. One of the main goals of investing in individual stocks is to achieve returns above those of the overall market for a given level of risk. Most stocks react to market moves in a consistent pattern. Further investigation is warranted if the price movement of a stock suddenly starts to deviate from its past relationship with the market or related index. Even if the company appears to be in the same condition as it was when you bought it, a lagging stock price in relation to the overall market may mean that there is a group of investors that believe that the stock's fundamentals have changed. In this situation, you might consider liquidating your position instead of waiting for information to surface. Buying stocks is easy. Anybody can do that. The hard part is when to sell. And very few people know how to do that. We have all made expensive mistakes - either missing the full upside by selling too soon, or taking a huge loss by holding a falling stock too long. Let us face it, most people don't know when to sell a falling stock. So they are frozen into inactivity. Question is "Should I just keep holding and hoping, or should I cut my losses now?" And there's no reliable crystal ball to tell anyone when a rising stock has peaked. The problem that causes both these mistakes to happen is simple: Ordinary investors are ruled by emotions. And the only way you are ever going to join the highest echelon of the world's best investors is to strip all emotions out of your decisions. Greed, fear, worry and nervousness-all these feelings have to go. Here is our advice on how to do it: While you will never be able to sell at the peak each and every time you invest, or ensure that you never buy a stock that subsequently falls dramatically, there is a secret weapon that is proven to get you the lion's share of any move. When you buy a stock, you buy it with the intention to sell it for a profit some time in the future. In order to do so successfully, you should put as much thought into planning your exit strategy as you put into the research that motivates you to buy the investment in the first place. We call this our "trailing stop strategy." All great traders and investors consistently cut losses short and let their profits run, great investors have found "trailing stop" is one of the easiest and most effective ways of doing that. In the stock market, you must have a strategy that makes you methodically cut your losses and let your winners ride. If you follow this rule, you have the best chance of outperforming the markets. If you don't, your retirement is in trouble. 'Trailing stop' strategy is a 25 per cent rule. We will sell positions at 25 per cent off their highs. For example, if we buy a stock at Tk 50, and it rises to Tk 100, when do we sell it? When it falls back to Tk 75 or 25 per cent off our high. Here's how the 'trailing stop' strategy works: If you do hold on to a falling stock too long, the loss will often be far more than just 25 per cent. And all it takes is one big loss to set an investor back for years. Let us say you start off with Tk 100,000. A year later you have made 25 per cent (Tk 125,000). Same for the next year (Tk 156,250), and the next (Tk 195,300). But then after three years of 25 per cent annual gains, on the fourth year, you take a loss of 50 per cent. It puts you back below where you started, at Tk 97,660. Now, let us say you had a 25 per cent trailing stop during the year you lost 50 per cent. You would have been stopped out at Tk 146480. Then during the following three years (when you again profited by 25 per cent each year), your holdings would be Tk 286,000 at the end of that entire seven-year stretch. 'Value trading' - when the 'trailing stop' might work against you in the market: This is the famous strategy of Warren Buffet -- the most successful stock trader in the world. By its very nature, 'value trading' can work against the trailing stop. 'Value trading'-the system of buying strong companies at or near historical lows-implies that you may temporarily follow a stock down past a 'trailing stop' before it begins to rebound. With a 'trailing stop' in place, you may never see the rebound. Should I sell a stock that was doing well but has been declining for the past few weeks? All stocks will eventually have a price decline. It is normal for a stock that has been rising for an extended period of time to take a breather now and then and take a dip. As long as there is no news that accompanies this decline, investors may wish to use these short-term declines to add to their position. When looking at a fall in stock price, especially after a prolonged run-up, you should examine the decline in relation to the industry, as well as the trading volume accompanying the decline. If the stock declines significantly versus the industry or if there is above-average volume as the price falls, you may want to consider selling the position. However, if the stock is down on average volume, you may want to buy additional shares. The key, again, is whether the fundamentals of the company have changed. What should I do if the stock price has been declining for a long period for no apparent reason? No investor likes to see the value of his or her shares decline over a long period, especially if there appears to be no contributing factor(s) to the decline. As prices decline, there will be those investors who believe that the market as a whole is more knowledgeable than they are and enter into a "herd" mentality, selling their shares and further lowering the price. There are others who take a contrarian approach, believing that sellers are overreacting. Such investors will add to their positions as the price drops, taking advantage of what they believe to be a bargain price. Most professional investors view a slow, steady decline in a stock's price as an excellent buying opportunity. Their reasoning is that if there were real problems with the company, the rush of investors to sell would force the price down sharply in a short period of time. Instead, they theorise that declines in price are caused by money managers selling their stake in a company to raise money and this, in turn, causes some investors to follow suit. Though many other external factors can still influence the market. Last few months, the role of the central bank is also under question, the role of regulatory body and the stock exchanges are also not transparent. We are confused with the earning per share (EPS) of many securities. EPS of many shares are abnormally fluctuating from quarter to quarter. We always suffer with inconsistent dividend policy of some companies. If you want to be a professional full-time stock trader, you must adopt at least few of the above mentioned strategy to profitably remain in the business. The biggest problem many investors face is that they become too emotionally involved and lose objectivity when deciding whether it is time to sell. Maintaining your objectivity during these times is important to your investing success. Unfortunately, there are no simple, mechanical rules that are effective for when to sell a stock. Nothing substitutes for an understanding of what economic, industry, and firm fundamentals drive your stock's price. By examining the situation rationally and doing your homework to determine if the fundamentals of the company have changed, you are better equipped to determine whether the time has come to sell your stake. An engineer, the writer is a trainer at Dhaka Chamber of Commerce and Industry. He can be reached at e-mail: mainuddin40@yahoo.com
Stock trading is now very much a burning issue in Bangladesh. Last few months many investors lost their money in the share trading business. Most of the share investors are still not aware about the strategies of the business as they are driven by rumor. But there is no alternative to knowledge and education regarding sustainable stock business. With this view, I am highlighting a few important strategies for the share trading business. The decision to sell a stock should be similar to the decision to buy a stock. But the price paid for a stock must be put aside when deciding if it is time to sell. The sell decision should focus on a company's future prospects and fundamentals relative to its current stock price. If the reasons for buying the company-i.e., its fundamentals-have not changed, then there may be no reason to sell. Many investors lose sight of this and allow their emotions to dictate their sell decisions. In investing, there are a few universal truths. One of them is that at some point, a stock's price will fall. There are myriad of reasons why a stock's price falls and it is up to you to determine the cause. By identifying why the price is falling, you are far better equipped to decide if it is time to sell your position or if the fall in value presents an opportunity to purchase additional shares. The key is neither to react every time a stock you own dips, nor to become so emotionally attached to an investment that you stay with it no matter what the news. Weakness in the overall market, by itself, is never a good reason to sell your stocks. Share markets rise and fall, but history has shown that over the long term a well-diversified portfolio of stocks will not only generate a positive return, but also provide the best opportunity for providing a return above the rate of inflation. It is important to keep your investment horizon in mind-long-term investors should not be deterred by short-term declines. It is a good idea, however, to compare the performance of an individual stock to that of the overall market. One of the main goals of investing in individual stocks is to achieve returns above those of the overall market for a given level of risk. Most stocks react to market moves in a consistent pattern. Further investigation is warranted if the price movement of a stock suddenly starts to deviate from its past relationship with the market or related index. Even if the company appears to be in the same condition as it was when you bought it, a lagging stock price in relation to the overall market may mean that there is a group of investors that believe that the stock's fundamentals have changed. In this situation, you might consider liquidating your position instead of waiting for information to surface. Buying stocks is easy. Anybody can do that. The hard part is when to sell. And very few people know how to do that. We have all made expensive mistakes - either missing the full upside by selling too soon, or taking a huge loss by holding a falling stock too long. Let us face it, most people don't know when to sell a falling stock. So they are frozen into inactivity. Question is "Should I just keep holding and hoping, or should I cut my losses now?" And there's no reliable crystal ball to tell anyone when a rising stock has peaked. The problem that causes both these mistakes to happen is simple: Ordinary investors are ruled by emotions. And the only way you are ever going to join the highest echelon of the world's best investors is to strip all emotions out of your decisions. Greed, fear, worry and nervousness-all these feelings have to go. Here is our advice on how to do it: While you will never be able to sell at the peak each and every time you invest, or ensure that you never buy a stock that subsequently falls dramatically, there is a secret weapon that is proven to get you the lion's share of any move. When you buy a stock, you buy it with the intention to sell it for a profit some time in the future. In order to do so successfully, you should put as much thought into planning your exit strategy as you put into the research that motivates you to buy the investment in the first place. We call this our "trailing stop strategy." All great traders and investors consistently cut losses short and let their profits run, great investors have found "trailing stop" is one of the easiest and most effective ways of doing that. In the stock market, you must have a strategy that makes you methodically cut your losses and let your winners ride. If you follow this rule, you have the best chance of outperforming the markets. If you don't, your retirement is in trouble. 'Trailing stop' strategy is a 25 per cent rule. We will sell positions at 25 per cent off their highs. For example, if we buy a stock at Tk 50, and it rises to Tk 100, when do we sell it? When it falls back to Tk 75 or 25 per cent off our high. Here's how the 'trailing stop' strategy works: If you do hold on to a falling stock too long, the loss will often be far more than just 25 per cent. And all it takes is one big loss to set an investor back for years. Let us say you start off with Tk 100,000. A year later you have made 25 per cent (Tk 125,000). Same for the next year (Tk 156,250), and the next (Tk 195,300). But then after three years of 25 per cent annual gains, on the fourth year, you take a loss of 50 per cent. It puts you back below where you started, at Tk 97,660. Now, let us say you had a 25 per cent trailing stop during the year you lost 50 per cent. You would have been stopped out at Tk 146480. Then during the following three years (when you again profited by 25 per cent each year), your holdings would be Tk 286,000 at the end of that entire seven-year stretch. 'Value trading' - when the 'trailing stop' might work against you in the market: This is the famous strategy of Warren Buffet -- the most successful stock trader in the world. By its very nature, 'value trading' can work against the trailing stop. 'Value trading'-the system of buying strong companies at or near historical lows-implies that you may temporarily follow a stock down past a 'trailing stop' before it begins to rebound. With a 'trailing stop' in place, you may never see the rebound. Should I sell a stock that was doing well but has been declining for the past few weeks? All stocks will eventually have a price decline. It is normal for a stock that has been rising for an extended period of time to take a breather now and then and take a dip. As long as there is no news that accompanies this decline, investors may wish to use these short-term declines to add to their position. When looking at a fall in stock price, especially after a prolonged run-up, you should examine the decline in relation to the industry, as well as the trading volume accompanying the decline. If the stock declines significantly versus the industry or if there is above-average volume as the price falls, you may want to consider selling the position. However, if the stock is down on average volume, you may want to buy additional shares. The key, again, is whether the fundamentals of the company have changed. What should I do if the stock price has been declining for a long period for no apparent reason? No investor likes to see the value of his or her shares decline over a long period, especially if there appears to be no contributing factor(s) to the decline. As prices decline, there will be those investors who believe that the market as a whole is more knowledgeable than they are and enter into a "herd" mentality, selling their shares and further lowering the price. There are others who take a contrarian approach, believing that sellers are overreacting. Such investors will add to their positions as the price drops, taking advantage of what they believe to be a bargain price. Most professional investors view a slow, steady decline in a stock's price as an excellent buying opportunity. Their reasoning is that if there were real problems with the company, the rush of investors to sell would force the price down sharply in a short period of time. Instead, they theorise that declines in price are caused by money managers selling their stake in a company to raise money and this, in turn, causes some investors to follow suit. Though many other external factors can still influence the market. Last few months, the role of the central bank is also under question, the role of regulatory body and the stock exchanges are also not transparent. We are confused with the earning per share (EPS) of many securities. EPS of many shares are abnormally fluctuating from quarter to quarter. We always suffer with inconsistent dividend policy of some companies. If you want to be a professional full-time stock trader, you must adopt at least few of the above mentioned strategy to profitably remain in the business. The biggest problem many investors face is that they become too emotionally involved and lose objectivity when deciding whether it is time to sell. Maintaining your objectivity during these times is important to your investing success. Unfortunately, there are no simple, mechanical rules that are effective for when to sell a stock. Nothing substitutes for an understanding of what economic, industry, and firm fundamentals drive your stock's price. By examining the situation rationally and doing your homework to determine if the fundamentals of the company have changed, you are better equipped to determine whether the time has come to sell your stake. An engineer, the writer is a trainer at Dhaka Chamber of Commerce and Industry. He can be reached at e-mail: mainuddin40@yahoo.com