ODDSMAKERS WILL ALWAYS
handicap the favorites. But at the start of every baseball season, all teams even longtimelosers
As the wheeling-dealing gets underway, investors should approach every trade with the confidence of Warren Buffett and the wisdom of a blackjack dealer, who knows that even the best players have plenty of losing hands. Although most people want to slap a "time horizon" on their trades, the truth is that the market should decide your holding period, not emotions or research. Every long-term investment starts out the same way as a short-term trade.
In my view, an appropriately sized initial position is no more than 5% of your overall portfolio. Once you get your trade confirmation, all the analyst reports and newsletter recommendations become moot. As we've pointed out in the past, after the first trade is made, it's all in the follow through. Your job isn't to research, but react.
Of course, trading can be addictive, and with more than 12,000 public companies, there's never a shortage of intriguing investment ideas. Indeed, it's human nature to want to tinker with your portfolio. And because the grass is always greener on the other side (or in another stock), too often we sell winning positions way too early, opting for a small profit and the exciting chance to go out for another "big kill."
I never go into a trade with a set "time horizon" of how long I plan to hold on. If the stock moves against me, I could be out in a day or less. But as long as it's going my way, I do my best to stay in the position. When the trend is your friend, remain a committed holder, even through the occasional hiccup, sell-off or mild slump. Although we operate on a rigid schedule of news cycles, trading hours and quarterly reports, the market is on nobody's timetable but its own.
Unfortunately, patience is in decidedly short supply. They want the market to function like some type of infinite cash machine. Just stick in your card and watch the hundreds tumble out.
But the big moves don't happen over minutes, but months. So the duration of any one particular trade shouldn't be a function of the psychological need for a "win" but rather the stock's price action. Without a doubt, the best traders work around the market's schedule, not their own. They know that just because they have gains doesn't mean they should take them. Instead, investors should think of "taking" as another word for "stopping." Take a loss and you've stopped it from growing. Take a gain and you've stopped the exact reason you got in XYZ in the first place.
The main reason to consider selling a stock is that it has grown to dominate your entire portfolio, making it uncomfortably volatile. Another reason, and the most common, to consider selling a stock is that its decline in price begins to have a major impact on your bottom line. While past performance isn't a guarantee of future result, it tends to be a pretty good indicator nonetheless. Weak stocks are weak for a reason. Let them be.
But oftentimes a stock will rise sharply and then consolidate for a period of months or more. How do you know if should you keep it for the long term, or simply take the money and run?
Like most aspects of trading, it comes down to efficient asset allocation. While you usually can afford to wait on a position, holding out for an entire portfolio is a recipe for disaster, as many former technophiles can attest. So when one of my major holdings turns from hot to not, I'll reduce my exposure but I won't eliminate it altogether. Like a wall full of trophy taxidermies, you'll want to keep at least a piece of the trade in your portfolio for as long as possible. Winning positions tend to continue to grow over time, even after the initial growth spurt. Keeping a position in a winning trade is a prudent move.
Ultimately, the market, not the pundits, analysts or experts, will decide when it's time for you to sell. While we do our research and invest accordingly, nobody knows what will ultimately happen. Predicting the future is impossible but anticipating it in a rational way isn't.
Because a big part of trading is not trading>, you'll need a few nonmarket activities to keep your finger out of the fudge pot. Video games, eBay and Funbets.com are among the no-stakes distractions that keep me busy when I'm tempted to sell too early. If that doesn't work, try setting a series of trailing stops and simply turn off your computer screen. Let your broker do the dirty work for you.
In the final analysis, stop orders tend to be the best approach, because the market is going wherever it damn well pleases, whether or not we watch its every move. And if you focus on cutting losses, the gains tend to take care of themselves.
Jonathan Hoenig is portfolio manager at Capitalistpig, a Chicago-based hedge fund.>