This post is a continuation of my earlier posts. I suggest reading The Art of Selling - Preview,
The Art of Selling - Winning the Loser's Game, and
The Art of Selling - Who is on the Other Side? before you read this post.
10 Commandments of Selling Stocks
Like I hinted at in my very first post on this topic, there aren’t any books on ‘how to sell stocks’. So, what I have framed are the 10 commandments that make a ton of sense to me. I have also provided attribution for the sources.
In terms of ‘further reading material’, there are three books. These are:
1. Thomas Phelps wrote an amazing book called 100 to 1 in the Stock Market. It was first published in the late 1972. The book has stood the test of time. A recent book that has also been published is called 100 Baggers and has been written by Christopher Mayer - it is an adaptation of the book that Phelps published and Mayer has stated that. Both are great reads.
2. Philip Fisher wrote Common Stocks and Uncommon Profits and Other Writings; his book was first published in 1957. Again, it is a superb read.
One can summarise the 10 commandments of Selling Stocks as under:
1. Never, if you can help it, take an investment action for a non-investment reason. (Thomas Phelps).
2. My Stock is too high is a fundamentally incorrect construct, wrong framing and wrong context. (Thomas Phelps).
3. I need to realise capital gains to offset realised capital losses in prior years (for tax). (Thomas Phelps).
4. My stock is not moving. (Thomas Phelps).
5. Let us fall back on the principle that when any rule or formula become a substitute for thought rather than an aid to thinking, it is dangerous and should be discarded. (Thomas Phelps)
6. You've made a mistake, if the factual background of the particular company is less favourable than believed, then one may sell. (Philip Fisher)
7. Any stock that no longer meets your investment criteria should be sold. (Philip Fisher)
8. You want to switch into something better - although an investor should be careful here and only switch if he or she is ‘very sure of his ground.’ (Philip Fisher)
9. If the job has been correctly done when a common stock is purchased, the time to sell it is – almost never. (Philip Fisher)
10. Selling your winners and holding your losers is like cutting the flowers and watering the weeds. (Peter Lynch)
That’s it! Everything else that has been written about the selling function by anyone is a derivative of the above. One of the remarkable things that strikes me as being consistent among these three gentlemen is this: none of these reasons has anything to do with the current price of the stock or with what price the stock was bought. Isn’t that amazing!.
Obscurity of expression is the hallmark of a Guru. To understand what the above 10 commandments mean, we have to read between the lines. I have tried to do that, and this is what I came up with.
1. If you’re in the business of trading stocks, then you’re probably wasting your time reading anything that I write. So, for the long-term, buy and hold investor, the fundamental question is: ‘Why do I want to Sell?’. My experience is that we don’t ask ourselves this question. (The most common reason that most of us attribute to our selling decision is: ‘Valuation’ - we want to buy it back ‘later’ when it ‘corrects’; I will tackle ‘Valuation’ in a separate post). I can’t resist quoting Buffett here: “Markets can do anything. If you look at the history of markets, you see everything under the sun. But we have no time frame [for doing something]. If the money piles up, then it piles up. And when we see something that makes sense, we're willing to act very fast and very big. But we're not going to act on anything if it doesn't check out. You don't get paid for activity. You only get paid for being right.”
2. If one has made a mistake, the bigger sin is staying wrong. Being wrong is par for the course, staying wrong is dumb. The problem is that cutting our losses requires us to overcome our behavioural biases. It isn’t easy.
3. Booking a profit to cover losses and for taxation is a pretty common reason for selling. The problem is that the basic decision to sell has nothing to do with the underlying business. And more often than not, it just doesn’t work out.
4. Selling because ‘my stock isn’t moving and everything else is’, is pernicious. Have any of you ever had the feeling that a stock that just sits there . . month after month . . . ugly . . . lifeless . . somehow knows when you sell it? And picks the very next day (or maybe the same day after we’ve sold), to turn from a frog to a prince? Buffett again: "That is one of the first things you have to learn about a stock. You buy 100 shares of General Motors (NYSE:GM). Now all of a sudden, you have this feeling about GM. It goes down, you may be mad at it. You may say, 'Well, if it just goes up for what I paid for it, my life will be wonderful again.' Or if it goes up, you may say how smart you were and how you and GM have this love affair. You have all these feelings. But the stock doesn't know you own it. The stock just sits there; it doesn't care what you paid or the fact that you own it. Any feeling I have about the market is not reciprocated. I mean it is the ultimate cold shoulder."
5. One of the subtle interpretations of these commandments is that these Gurus were very selective about what they bought. Their buying criteria are so stringent that the question of selling arises only if they have made an error of judgment.
6. Selling a stock to buy another name, would make sense only after we have made an assessment of the opportunity cost of not selling. Every time you sell something and book a profit, in most cases we are looking to invest some place else, and if we are looking for another stock to invest in, it is just another opportunity to be wrong. A necessary corollary of this is applicable when we sell our winners. Because, what matters is the magnitude of gain when one is right, and not the frequency with which one gets it right.
7. Some investors have a rule or formula whereby they sell some portion of their winning positions when the market price doubles or the stock price rises by a pre-decided percentage. These very investors seldom have similar rules for their loss making positions. In other words, their loss percentage is 100 percent and the profit percentage is fixed by them even before they trade. This is a negative sum game and makes little sense.
8. The most important reason for cultivating a selling aversion is because one loses the power of compounding. And since compounding works exponentially, we shouldn't interrupt the compounding mechanism. This is mathematical again, but it is very true.
9. If the weight of the stock in your portfolio has become disproportionately large, then a common practise is to trim positions. This is very subjective. How does one calculate the weight of a stock in a portfolio? I think one should do it based on what it has cost us. But most investors seem to use the current market value instead. More important is the fact that, irrespective of how you calculate portfolio weight, it still doesn’t qualify as a reason to sell.
10. Commodity stocks are notoriously cyclical and most investors try to get out of the names before the cycle peaks. Most of us get the timing wrong. And then there are those, who don’t buy commodities because of the cyclicality.
11. Staring at stock prices, and at our portfolio performance, comparing it with the index over the short-term is a bad idea. Many investors use their ‘reading of the screen’ as the basis for their buy and sell decisions. I can almost hear the push back to the above statement. But, the research proves otherwise.
12. When an analyst at a reputed or well regarded fund house downgrades a stock or a sector, they publish a Sell or the more commonly used terminology is Underweight rating. This leads to a negative reaction in the stock price. Investors are tempted to sell, and more often than not, do end up selling. The question is - what does this downgrade mean for us? It gets very ironic when the same fund house after a couple of months issues a hold rating. How can I hold, I don’t own it anymore, you asked me to sell, didn’t you? To put things in the correct perspective, analyst ratings mean nothing. Does the stock price decide management quality, business prospects or any other metric? It doesn't - the stock price is the clearing price and it matters only twice - once when we buy a stock and again when we decide to sell it; everything else is pure entertainment (noise) - financial porn, if you will!
Selling by Fund Managers
Most of what I’ve written till date about the Art of Selling, applies to individual investing in stocks. The fact is that most investors do this via the Mutual Fund Schemes route. Fund houses manage mutual funds and each scheme has a fund manager. This fund manager is a human being, but that doesn’t matter to most investors, since they seem to invest based on the past performance of the fund. In reality, the Fund Manager takes all the Buy and Sell calls on behalf of the investors in the fund. The next question is: how good are fund managers at Selling Stocks. Now there is published research on this very topic.
Selling Fast and Buying Slow: Heuristics and Trading Performance of Institutional Investors by Klakow Akepanidtaworn, Rick Di Mascio, Alex Imas, and Lawrence Schmidt has been published as recently as July 2021. For those of you who don’t want to read the whole paper, here are the relevant parts.
1. The researchers looked at a database of buying and selling decisions made by professional fund managers in 783 different portfolios between 2000 and 2016 (so a decent time period).
2. We often criticise active fund managers for failing to beat their benchmarks over the long term. The researchers found that this is down to one specific part of the trading process. As the paper puts it: “While the investors display apparent skill in buying, their selling decisions underperformed.” With selling, managers were awful: “selling decisions not only fail to beat a no-skill random selling strategy, they consistently underperform it”.
3. The researchers also comment on why this is the case - “they appear to focus on finding the next great idea to add to their portfolio and view selling largely to raise cash for purchases.”
Bottom line: Selling is way more difficult than buying.
What about the ‘Never Sell’ crowd?
There is an overriding caveat to all the above - the business that the name of a stock represents has to be within the Circle of Competence of the investor. One should understand the underlying business model of the company, only then can we hold it for very long periods of time. This isn’t always true for most of us. There is a way out and I will write about that in my next post.
Click here to go back to The Art of Selling - Index
To view this post in your browser or to share it click 10 Commandments
The Art of Selling - Winning the Loser's Game, and
The Art of Selling - Who is on the Other Side? before you read this post.
10 Commandments of Selling Stocks
Like I hinted at in my very first post on this topic, there aren’t any books on ‘how to sell stocks’. So, what I have framed are the 10 commandments that make a ton of sense to me. I have also provided attribution for the sources.
In terms of ‘further reading material’, there are three books. These are:
1. Thomas Phelps wrote an amazing book called 100 to 1 in the Stock Market. It was first published in the late 1972. The book has stood the test of time. A recent book that has also been published is called 100 Baggers and has been written by Christopher Mayer - it is an adaptation of the book that Phelps published and Mayer has stated that. Both are great reads.
2. Philip Fisher wrote Common Stocks and Uncommon Profits and Other Writings; his book was first published in 1957. Again, it is a superb read.
One can summarise the 10 commandments of Selling Stocks as under:
1. Never, if you can help it, take an investment action for a non-investment reason. (Thomas Phelps).
2. My Stock is too high is a fundamentally incorrect construct, wrong framing and wrong context. (Thomas Phelps).
3. I need to realise capital gains to offset realised capital losses in prior years (for tax). (Thomas Phelps).
4. My stock is not moving. (Thomas Phelps).
5. Let us fall back on the principle that when any rule or formula become a substitute for thought rather than an aid to thinking, it is dangerous and should be discarded. (Thomas Phelps)
6. You've made a mistake, if the factual background of the particular company is less favourable than believed, then one may sell. (Philip Fisher)
7. Any stock that no longer meets your investment criteria should be sold. (Philip Fisher)
8. You want to switch into something better - although an investor should be careful here and only switch if he or she is ‘very sure of his ground.’ (Philip Fisher)
9. If the job has been correctly done when a common stock is purchased, the time to sell it is – almost never. (Philip Fisher)
10. Selling your winners and holding your losers is like cutting the flowers and watering the weeds. (Peter Lynch)
That’s it! Everything else that has been written about the selling function by anyone is a derivative of the above. One of the remarkable things that strikes me as being consistent among these three gentlemen is this: none of these reasons has anything to do with the current price of the stock or with what price the stock was bought. Isn’t that amazing!.
Obscurity of expression is the hallmark of a Guru. To understand what the above 10 commandments mean, we have to read between the lines. I have tried to do that, and this is what I came up with.
1. If you’re in the business of trading stocks, then you’re probably wasting your time reading anything that I write. So, for the long-term, buy and hold investor, the fundamental question is: ‘Why do I want to Sell?’. My experience is that we don’t ask ourselves this question. (The most common reason that most of us attribute to our selling decision is: ‘Valuation’ - we want to buy it back ‘later’ when it ‘corrects’; I will tackle ‘Valuation’ in a separate post). I can’t resist quoting Buffett here: “Markets can do anything. If you look at the history of markets, you see everything under the sun. But we have no time frame [for doing something]. If the money piles up, then it piles up. And when we see something that makes sense, we're willing to act very fast and very big. But we're not going to act on anything if it doesn't check out. You don't get paid for activity. You only get paid for being right.”
2. If one has made a mistake, the bigger sin is staying wrong. Being wrong is par for the course, staying wrong is dumb. The problem is that cutting our losses requires us to overcome our behavioural biases. It isn’t easy.
3. Booking a profit to cover losses and for taxation is a pretty common reason for selling. The problem is that the basic decision to sell has nothing to do with the underlying business. And more often than not, it just doesn’t work out.
4. Selling because ‘my stock isn’t moving and everything else is’, is pernicious. Have any of you ever had the feeling that a stock that just sits there . . month after month . . . ugly . . . lifeless . . somehow knows when you sell it? And picks the very next day (or maybe the same day after we’ve sold), to turn from a frog to a prince? Buffett again: "That is one of the first things you have to learn about a stock. You buy 100 shares of General Motors (NYSE:GM). Now all of a sudden, you have this feeling about GM. It goes down, you may be mad at it. You may say, 'Well, if it just goes up for what I paid for it, my life will be wonderful again.' Or if it goes up, you may say how smart you were and how you and GM have this love affair. You have all these feelings. But the stock doesn't know you own it. The stock just sits there; it doesn't care what you paid or the fact that you own it. Any feeling I have about the market is not reciprocated. I mean it is the ultimate cold shoulder."
5. One of the subtle interpretations of these commandments is that these Gurus were very selective about what they bought. Their buying criteria are so stringent that the question of selling arises only if they have made an error of judgment.
6. Selling a stock to buy another name, would make sense only after we have made an assessment of the opportunity cost of not selling. Every time you sell something and book a profit, in most cases we are looking to invest some place else, and if we are looking for another stock to invest in, it is just another opportunity to be wrong. A necessary corollary of this is applicable when we sell our winners. Because, what matters is the magnitude of gain when one is right, and not the frequency with which one gets it right.
7. Some investors have a rule or formula whereby they sell some portion of their winning positions when the market price doubles or the stock price rises by a pre-decided percentage. These very investors seldom have similar rules for their loss making positions. In other words, their loss percentage is 100 percent and the profit percentage is fixed by them even before they trade. This is a negative sum game and makes little sense.
8. The most important reason for cultivating a selling aversion is because one loses the power of compounding. And since compounding works exponentially, we shouldn't interrupt the compounding mechanism. This is mathematical again, but it is very true.
9. If the weight of the stock in your portfolio has become disproportionately large, then a common practise is to trim positions. This is very subjective. How does one calculate the weight of a stock in a portfolio? I think one should do it based on what it has cost us. But most investors seem to use the current market value instead. More important is the fact that, irrespective of how you calculate portfolio weight, it still doesn’t qualify as a reason to sell.
10. Commodity stocks are notoriously cyclical and most investors try to get out of the names before the cycle peaks. Most of us get the timing wrong. And then there are those, who don’t buy commodities because of the cyclicality.
11. Staring at stock prices, and at our portfolio performance, comparing it with the index over the short-term is a bad idea. Many investors use their ‘reading of the screen’ as the basis for their buy and sell decisions. I can almost hear the push back to the above statement. But, the research proves otherwise.
12. When an analyst at a reputed or well regarded fund house downgrades a stock or a sector, they publish a Sell or the more commonly used terminology is Underweight rating. This leads to a negative reaction in the stock price. Investors are tempted to sell, and more often than not, do end up selling. The question is - what does this downgrade mean for us? It gets very ironic when the same fund house after a couple of months issues a hold rating. How can I hold, I don’t own it anymore, you asked me to sell, didn’t you? To put things in the correct perspective, analyst ratings mean nothing. Does the stock price decide management quality, business prospects or any other metric? It doesn't - the stock price is the clearing price and it matters only twice - once when we buy a stock and again when we decide to sell it; everything else is pure entertainment (noise) - financial porn, if you will!
Selling by Fund Managers
Most of what I’ve written till date about the Art of Selling, applies to individual investing in stocks. The fact is that most investors do this via the Mutual Fund Schemes route. Fund houses manage mutual funds and each scheme has a fund manager. This fund manager is a human being, but that doesn’t matter to most investors, since they seem to invest based on the past performance of the fund. In reality, the Fund Manager takes all the Buy and Sell calls on behalf of the investors in the fund. The next question is: how good are fund managers at Selling Stocks. Now there is published research on this very topic.
Selling Fast and Buying Slow: Heuristics and Trading Performance of Institutional Investors by Klakow Akepanidtaworn, Rick Di Mascio, Alex Imas, and Lawrence Schmidt has been published as recently as July 2021. For those of you who don’t want to read the whole paper, here are the relevant parts.
1. The researchers looked at a database of buying and selling decisions made by professional fund managers in 783 different portfolios between 2000 and 2016 (so a decent time period).
2. We often criticise active fund managers for failing to beat their benchmarks over the long term. The researchers found that this is down to one specific part of the trading process. As the paper puts it: “While the investors display apparent skill in buying, their selling decisions underperformed.” With selling, managers were awful: “selling decisions not only fail to beat a no-skill random selling strategy, they consistently underperform it”.
3. The researchers also comment on why this is the case - “they appear to focus on finding the next great idea to add to their portfolio and view selling largely to raise cash for purchases.”
Bottom line: Selling is way more difficult than buying.
What about the ‘Never Sell’ crowd?
There is an overriding caveat to all the above - the business that the name of a stock represents has to be within the Circle of Competence of the investor. One should understand the underlying business model of the company, only then can we hold it for very long periods of time. This isn’t always true for most of us. There is a way out and I will write about that in my next post.
Click here to go back to The Art of Selling - Index
To view this post in your browser or to share it click 10 Commandments