The ability to sell underperforming stocks before losers build and even to short certain stocks, is key to trading and investing success, writes Landon Whaley.
Do you want to know the single greatest attribute required to be a consistently successful investor? The ability to sell. I’m talking about both an articulated strategy for selling long positions that aren’t working and for short selling stocks poised to take the elevator shaft lower. In the investing game, if you want to be great, you’d better learn how to sell.
First, you must have an articulated sell strategy for your long positions because the only aspect of the investing process that is under your control is the losses you take on losing trades. Generating positive returns each calendar year regardless of economic or financial market conditions requires you to minimize the time spent in a capital drawdown, and the only way to do that is to limit the losses on individual trades. Most investors don’t realize that their performance each year is entirely determined by the number and size of their losers and not by the greatness of their winners. Talk to some of the most successful money managers, and they invariably will tell you that they are most proud of the losing trades where they were able limit the scope of their losses as they are of their winners.
Second, the need for an articulated short selling strategy is simple math. Since Q1 1990, there have been 120 calendar quarters of economic activity. The United States has spent 48% of that time in either a Spring or Summer Fundamental Gravity (bullish), 31% in Fall (nuanced but mildly bearish), and 21% of that period in Winter (bearish). If you aren’t a competent short seller, then you missed profitable opportunities and enhanced downside risk management during the 52% of the time when the U.S. was experiencing bearish market conditions. To be a consistently successful investor, you must be able to play the investing game in all four seasons.
Do you know who doesn’t have either of these “sell” capabilities? Wall Street.
On Wall Street, “sell” is a four-letter word because their entire compensation structure is based on enticing more and more capital inflows to grow assets under management and cram IPOs down the throats of unsuspecting investors. They never want you to sell any investment you make, and they hound you to continually add more of your hard-earned shekels regardless of prevailing economic or financial market conditions!
Speaking of which, when was the last time you saw a “sell” rating on a stock? Let me help. There are currently 3,214 U.S. stocks that carry an analyst rating. Out of these more than 3,000 publicly traded companies, only 30 are rated “sell,” and just two companies have the dreaded “strong sell” rating.
In addition to the 32 companies with the analyst-equivalent of the Coronavirus, there are 2,251 companies with a “strong-buy” or “buy” rating and 931 with a “hold” rating. Wall Street analysts are telling investors that 70% of U.S. stocks are worthy of investment, 29% of stocks should be treated with a “wait and see” approach, and only 1% are losers. I couldn’t make this up if I tried!
You see, as an analyst, once you’ve slapped a “sell” rating (or even a “hold”) on a company, then your firm is never getting that company’s investment banking business. On Wall Street, that’s a big no-no because the investment banking division of any firm produces far more revenue than research.
Wall Street can’t sell, but if you’re interested in wealth creation and preservation with minimal drawdowns, then you’ll heed my guidance: learn to sell your losers quickly and to go hunting opportunistically for short stocks when its Fall or Winter.
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