Selling before it’s too late- The delusion of paper profits in a bull market

Selling stocks is exponentially more difficult than buying. If you sell a winner at the wrong time, you could have the financial regret of a lifetime. On the flip side, there were times I ended up kicking myself for not having sold losing stocks in time, thereby magnifying the somewhat inevitable smaller losses I would have otherwise had.

It takes quite a few trials and errors before one figures out how to sell stocks in time. And even after one thinks he’s got it, could still go wrong.

The context is that like a lot of my peers, I was anxious about how this current bull run will play out. Will we experience another bull market like the one we experienced between 2009 and Feb 2020? Or will the market correct from here? If yes, then I shouldn’t be repeating the mistakes from the last cycle and convert paper profits to cash.

Bear markets sneak in when most poor mortals aren’t expecting them and not when there is a lot of debate on Twitter about whether it will crash this week or the next or the one after that.

While I am no expert at timing the markets or the macros, let me give this a shot anyway. In the aftermath of the 2008 housing bubble, the US Fed’s balance sheet expanded multi-fold and all those newly printed dollars chased equities and markets, the world over, shot up. Will the same story play out yet again over the next decade or so? A layman’s guess would be yes.

And here’s what somebody who has a good handle on macros, said about liquidity. Stanley Druckenmiller (left), one of the guys who famously broke the Bank of England, along with his mentor, the legendary, George Soros (right), in a highly leveraged bet, once said,

With liquidity, earnings and the several moving parts that work in the background to keep the market engine running, it is hard to make a sure shot prediction about market direction. Think about how many people got out in time before the March 2020 crash and whether the same set of people had the nerve to get back in time before the markets ran up so suddenly.

I don’t think there are easy answers to when a bear market will come or if at all it will be in the near future. While I have been dealing with this uncertainty in my mind, I’ve simultaneously been reading How to make money in stocks by William O’Neil. For somebody like me, who loves reading financial history, this book is an absolute delight.

O’Neil is a genius. He collated fundamental and technical data of historical multi baggers, as early as the year 1885. And he put them into his mainframe computer in the 1960s to analyze what works on Wall Street. So this guy got his hands on a mainframe (remember there was no Windows then) to analyze stocks much before Bill Gates was famously dozing off on his desk, working on computers, in 1968. Woah!!

How O’Neil collated and analyzed so much data at a time when computers used to work like the ones below is quite fascinating.

Anyway, like a lot of other things in life, one naively ignored idea is that of looking at history and seeing how others solved the same problem I am facing today. And here’s how O’Neil solved the problem of being able to sell winning stocks in time. He wrote –

“Have you ever analyzed every one of your failures so you can learn from them? Few people do. What a tragic mistake you’ll make if you don’t look carefully at yourself and the decisions you’ve made in the stock market that did not work. You get better only when you learn what you’ve done wrong. This is the difference between winners and losers, whether in the market or in life. If you got hurt in the 2000 or 2008 bear market, don’t get discouraged and quit. Plot out your mistakes on charts, study them, and write some additional new rules that, if you follow them, will correct your mistakes and let you avoid the actions that cost you a lot of time and money.”

Hmmm.. so he looked at his past trades and so should I. I have this excel sheet where I note down all my buy/sell trades. And here’s what I figured out by doing a post mortem of my past trades from that sheet. There is a bit of hindsight bias here but we’ll just need to work with what we have.

Relaxo Footwears

• I initially thought the stock will not do better than 15% returns per annum, and did not buy.
• Big opportunity loss due to not averaging up. I was anchored to low valuations or my cost price perhaps.
• Position sizing was not sufficient. Should have bought a lot more.

Nesco

• Prematurely sold due to fear of losing out gains already made.
• Did not apply second level thinking. Should have trusted management would fix the issue, because they would have solved the problem with their business sooner or later.

Kitex Garments

• Should not have bought the stock in the first place. I wasn’t looking hard enough.
• Averaging down did not help.
• Should have sold when EPS fell down. Did not cut losses quickly enough.

Bajaj Finance

• What worked – Buying when others were fearful.
• What didn’t – Process gap. Not adhering to my stop loss.

Alkyl Amines

• What worked – Experimental bet although it was outside my circle of competence.
• What didn’t – Not following up. Not averaging up.

The way I look at it is, my journey has been through 3 phases.

Phase 1 – Where I was neither buying nor selling correctly
Phase 2 – Where I was buying somewhat correctly but not selling correctly
Phase 3 (Hoping I am in phase 3 today) – Where I am buying correctly [High allocation bets like Alembic Pharma (exited), Laurus & RACL have done well since March 2020] and hoping to sell correctly.

It is foolish to keep repeating mistakes and I now have pre-determined stop loss prices for all my long term bets and I am hoping this kind of a process allows me to convert paper profits into real currency. Having pre-determined stops also helps get rid a lot of bias and inaction that comes when the stop price actually arrives. I am hoping this helps me to transition from phase 2 to phase 3 smoothly unless I figure out there are more holes in my process.

Perhaps there is a phase 4 too, that I can’t visualise today. Having said that, I am glad to have made it this far, the future seems exciting and there’s a lot more yet to be accomplished.

Note to self:

• Not backing up positions with enough capital, is a costly mistake. How many of your bets go right is less important than how much you allocate to the ones that go up. To quote Jeff Bezos, “Big winners pay for several failed experiments.” I seem to have fixed this mistake, by allocating 25% of my portfolio to Laurus Labs, last year.
• Avoid slow or non-growth businesses altogether. Just doesn’t work for my investing personality type.
• Not cutting losses quickly is a lacuna to be avoided.

Barath Mukhi
26th July 2021