February 22nd, 2013
The jarring correction over the past couple of days understandably sent shivers down my back. Should I start selling some of my winners in order to lock in those gains or just steel my nerves and hold on until this passes? I like most of my positions (currently over 70 stocks in the Model Portfolio) and the market is close to testing the strength of its momentum as it approaches what I have labeled the “Crunch Zone”, the area between the 2001 and 2007 all-time highs. Shouldn’t I do nothing and just wait? There is nothing in the technicals other than the fact of the approach to the all-time high to indicate that this is only another correction that the market has successfully weathered during the current bull market run since the 2009 bottom.
All of us are continually caught on the horns of this dilemma but even more so when the market is correcting: 1) hold on and run the risk of more significant losses or 2) sell and run the risk of unwinding some excellent positions. We usually evaluate our success as investors is to see whether our total returns (dividends and appreciation) are respectable. If we’re honest, we compare those returns against a benchmark [I use the S&P 500 Index] to see whether our efforts have produced returns in excess of what we would have earned in an Index Fund or ETF. What we don’t do often enough, however, is move beyond our current positions and analyze the previous trading that got us to where we are today.
- When did we sell stocks?
- How have the stocks that we did sell (often in panic in response to a market correction) perform after we had sold them?
- How did the portfolios of investors who bought our stocks from us perform after they took those stocks off our hands?
Since January 1, 2012, there were 87 sales transactions from the Model Portfolio. Some of those sales were swaps to move into other stocks and others were sales to reduce risk by moving into cash. I wanted to find out whether those sales were actually necessary? How did the sold stocks perform had I held on to them to the present? Did I sell winners or losers? Were the sales made as the market was rising or falling? What I can I learn from about my trading habits from those sales? For each transaction, I captured the gain/(loss) prior the sale, the gain/(loss) from the sale to current and the stock’s performance vs. the S&P 500 since the sale. Some of the results were surprising and revealing (click on image to enlarge):
Most interesting is that 65.5% of the sold stocks actually appreciated after the were sold. Luckily, most of the stocks sold continued to underperform since only 47% kept pace and 53% lagged the S&P 500 Index since their sale. Interestingly, the stocks with the largest gains after their sale were losers when I sold them. As a matter of fact, nearly 60% of the sold stocks that had losses prior to their sale have appreciated since. One of the largest post-sale gains was MTZ (click here for chart).
When were those stocks sold and should they have been? What was the market doing at the time of the sale? Except for one extremely short periods, the Market Momentum Meter has been Bullish Green since the end of January 2012 suggesting to Instant Alert Members that they have a fully invested posture (click on image to enlarge):
What stands out is that many of the sales occurred during months during and after the end of market corrections. For example, there were 19 sales in June and July after the Spring correction but only 9 in May and June when the correction was occurring; there were 11 sales during the Sept-Nov correction but 33 in the months after it had ended.
This may sound like overly personal but I think there are several lessons that anyone can take away from this exercise:
- It’s important to periodically review stock sales in addition to tracking stocks you currently own.
- Stick to a market timing discipline to avoid being unnecessarily scared out of the market when it is correcting.
- Continue to monitor stocks you’ve sold and buy them back rather than taking a risk on something untried if, after the correction ends, the stock continues its advance.
- Move into cash only when your market timing discipline indicates that the correction is likely to turn into a bear market reversal.