|
HISTORICAL GP's
|
| TUTORIALS |
|
BASICS
FUNDAMENTALS TECHNICALS ROLLING TC-2000 OPTIONS |
| THE OFFER |
|
OUR MISSION
SERVICES PRO-FUNDITY PAGE TESTIMONIALS CONTACTS |
| INFO STORE |
|
PORTFOLIO
FAQ |
| TOOLS&LINKS |
 SITE MAP TOOLS & LINKS |
Greetings, fellow Pro-fundity team members -
8-27-99 Page
- In our recent discussions about the Contrarian strategy to market investing we concluded last week with a summary of the "Buy Rules." These are the conditions under which a contrarian investor would put his/her money on the line. This week we will examine the more difficult decision, when to sell. Why is it more difficult to sell? Emotion. Before buying a stock, we are an observer. We can analyze to our hearts desire, hypothesize or fantasize different outcomes. But as soon as we buy, we have become committed. We are suddenly very emotionally involved. Above all, we don't want the decision we have just made to turn sour. This emotional tie can alter our judgement regarding the sale of the stock. If the stock drops we may buy more, thinking (hoping) we can push the stock up. On the other end, we may try to ride the stock too high, disregarding sell signals, and miss a profit thinking it will ever increase. All of this, taken together, sheds light on the pitfalls that accompany the task of selling at the right time. This week we will examine how the contratrian deals with this issue.
- First, review the previous Guideposts highlighting the contrarian buy rules:
A stock satisfies the Contrarian Buy Rules if it is:
1. Down by half AND 2. Meets either of two Confirming Indicators: 2a. Shows major insider buying OR 2b. Meets two of four fundamental indicators: - Price/Earnings (P/E) ratio of less than 12
- Price/Free Cash Flow (P/FCF) ratio of less than 10
- Price/Book value (P/BV) ratio of less than 1.0
- Price/Sales (P/S) ratio of less than 1.0
- Now, lets take the next step and examine the contrarian sell strategy.
- Three important rules guide the contrarian in the sale of stock:
- First and foremost, place a GTC (good until cancelled) stop-loss at 25% below the purchase price.
- Sell winners after a 50% profit, or after three years, whichever comes first.
- On winning stocks that have not satisfied rule 2, place a stop loss that guarantees a profit of 30% or more.
- The first rule is the common backup plan in virtually every investment strategy. We know the manic nature of the market and a stop-loss is an easy way to do just that, to stop the loss. Every stock we purchase will not forever go up. The stop-loss is a way to cut losses early so that over the long haul, the stocks we own spend more time on the up-side.
- If a stock is purchased at $10 per share, a stop-loss at $7.50 should be set immediately. In the contrarian buy strategy, picks are from the distressed stocks (down by half). Some won't make it. The stop loss keeps small losses from turning into big ones. A contrarian portfolio contains many stocks, none of which represent more than 5% of the total portfolio value. A 25% loss in one stock will then never be more than 1% of the portfolio. Eliminating the possibility of a large loss provides a big advantage over other investors.
- If a stop loss is triggered, the contrarian understands they won't make their money back on that particular stock. The profit will be made, only on a different stock. It is not true that if the stock isn't sold, it isn't a real loss.
- The first decision is whether to use a "mental" or a "mechanical" stop loss (with a broker as a GTC). Most investors don't actually set them because they don't want to commit themselves to selling a stock automatically. That is a mistake.
- The second rule forces the investor to look for new opportunities but not like a day- trader. It provides time to seriously analyze opportunities before jumping in. There are exceptions to this rule, where the investor may hold off selling at an increase of 50%, or after three years, if the company's prospects are so remarkable only the fool would sell. Remember the emotion factor here. Hope does not equate to remarkable performance and prospect.
- A great deal of research over the years has supported the three year rule as an investment strategy. Benjamin Graham, mentor to Warren Buffett and Wall Street guru suggested a position should be liquidated after a 50% profit, or two to three years from its purchase, whichever came first. The 50% limit is based on additional research that shows that stocks tended to under-perform the market after reaching this increased level.
- Exceptions to this rule (use only after serious introspection, remembering the damage greed can do to a position):
- When it is obvious the company will continue to improve. When the contrarian buys a stock that is down-by-half, a quick turn-around is not uncommon and it may be clear the 50% rise is just the beginning. When this occurs, simply raise the stop-loss to protect a 30% profit if the stock price falls back. In our earlier example, with the $10 purchase and a $7.50 stop-loss, when the stock rises to $15 and looks to be going higher, the stop loss should be moved up to $13 to guarantee a 30% profit.
- If new insider buying is evident ($120,000 during the past 6 months), that is a hold signal.
- When the "crowd" continues to be bearish on the stock while the price continues to climb, the true contrarian would sense the value of holding. The longer it takes for the crowd to come around, the greater the potential for higher return.
- If you continue to get continuous and positive feedback on the position. An important market maxim is to cut your losses and let your profits run. As long as the market endorses your judgement, you are on the correct side of the stock. However, if your profit at month's end is less than the previous month, it may be only a correction. Or it may be a peak. Whenever on the fence, not sure of which, sell and pocket the profits.
-
Summary:
The contrarian investor considers selling the most critical skill to be developed. As an investor in contrarian stocks, there will be two outcomes: Winners & losers. Three selling rules guide the effort for both to help maximize profits and to keep losses small: - The first deals with winners - Sell after a 50% profit or after three years, whichever comes first. The text above deals with some exceptions.
- The second deals with losers - Place a stop loss at 25% below purchase price at the time of purchase.
- The third combines the first two, protecting winners by moving the stop loss up to protect at least a 30% profit if the stock falls back.
- Next week we will review both buying and selling from the contrarians standpoint, looking for points of value for trading in rolling stocks.
This week's Editorial Guidepost:
Bibliography:
"The New Contrarian
Investment Strategy," David Dreman, Random House, 1982
"Contrarian Investing," Anthony
M. Gallea & William Patalon III, New York Institute of Finance, 1998
Stay tuned.
It is our intent to help our subscribers understand market strategies well enough to make informed decisions and understand the risks.
We provide TC-2000 tutorials to members. See the Member Login page.
[THE OFFER] [TOOLS&LINKS] [CONTACT US]
Linked sites on the Pro-fundity web site, that are not under the control of Pro-fundity, are provided as a convenience only. The inclusion of a link does not imply endorsement of the linked site or its content by Pro-fundity.