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Wednesday, December 3, 2008

The Art Of Selling A Losing Position / 综合指数 2008年 12月 02日 / Composite Index 02/12/2008

The Art Of Selling A Losing Position By Zhuge Liang


Your stock is losing value. You want to sell, but you can't bear to think of selling now before further losses or later when losses may or may not be larger. All you know is that you want to offload your holdings and preserve your capital and to reinvest the money in a more profitable security. In a perfect world, you'd always achieve this aim and sell at the right time. Unfortunately, it isn't that easy in real life. Let's take a look at why selling is important and then talk about a selling strategy that works for any type of investor.

The Breakeven Fallacy
There is absolutely no guarantee that a stock will ever come back. In fact, waiting to break even - the point at which profit equals losses - can seriously erode your returns. To demonstrate the importance of cutting losses, the chart below shows the amount a portfolio or security must rise after a drop just to get back to even.


Percentage Loss Percent Rise To Breakeven

10%----- 11%
15%----- 18%
20%----- 25%
25%----- 33%
30%----- 43%
35%----- 54%
40%----- 67%
45%----- 82%
50%---- 100%

A stock that declines 50% must increase 100% to break even! Think about it in ringgit terms: a stock that drops 50% from MYR10 to MYR5 (MYR5 / MYR10 = 50%) must rise by MYR5, or 100% (MYR5 / MYR5 = 100%), just to return to the original MYR10 purchase price. Many investors forget about simple mathematics and take in losses that are greater than they realize. They falsely believe that if a stock drops 20%, it will simply have to rise by that same percentage to break even.

This isn't to say that rebounds never happen. Sometimes a stock has been unfairly pummeled. But the long turnaround waiting period (about three to five years) also means the stock is tying up money that could be put to work in a different stock with much better potential. Always think in terms of future potential - you can't do anything about the past, so stop clinging to it!

The Best Offense Is a Good Defense
Championship teams have one thing in common - a good defense. This principle can be applied to the stock market as well. You can't win unless you have a predetermined defense strategy to prevent excessive losses. We say "predetermined" because either before or at the time of purchase is the time when you can think most clearly about why you would want to sell. You have no emotional attachment before you buy anything, so a rational decision is likely. Once we own something, we tend to let emotions such as greed or fear get in the way of good judgment.

An Adaptable Selling Strategy
A selling strategy that's successful for one person might not work for somebody else. Think about a short-term trader who sets a stop-loss order for a decline of 3%; this is a good strategy to reduce any big losses. The stop-loss strategy can be used by longer-term traders also, such as investors with a three- to five-year investment time frame. However, the percentage decline would be much higher, such as 15%, than that used by short-term traders. On the other hand, this stop-loss strategy becomes less and less useful as the investment time frame is extended.

If you're thinking about selling, ask yourself these questions:

1. Why did you buy the stock?
2. What changed?
3. Does that change affect your reasons for investing in the company?

This approach requires you to know something about your investing style. If you bought a stock because your Uncle Tan (Edmund?) said it would soar, you'll have trouble making the best decision for you. If, however, you've put some thought into your investment, this framework will help. The first question will be an easy one. Did you buy a company because it had a solid balance sheet? Were they developing a new product or technology that would one day take the market by storm? Whatever the reason was, it leads to the second question. Has the reason you bought the company changed? If a stock has gone down in price, there is usually a reason for it. Does the quality you originally liked in the company still exist, or has the company changed? It is important to not limit your research to only the original purchase reasons. Review all of the latest headlines related to that firm as well as its Securities Commission (SC) or BURSA filings for any events which could potentially diminish the reasons behind the investment. If after some research you see the same qualities as before, keep the stock.

If you have determined that there has been a change, then proceed to the third question: is the change material enough that you would not buy the company again? For example, does it alter the company's business model? If so, it is better for you to offload the position in the company, as its business plan has greatly diverged from the reasons behind your original investment. Remember not to get emotionally attached to companies, and making smart sell positions will become easier and easier.

Let's demonstrate how a value investor would use this approach.. Simply put, value investing is buying high-quality companies at a discount. The strategy requires extensive research into a company's fundamentals.

1. Why did you buy the stock?
Let's say our value investor only buys companies with a P/E ratio in the bottom 10% of the equity market, with earnings growth of 10% per year.

2. What changed?
Say the stock declines in price by 20%. Most investors would wince at seeing this much of their hard-earned dough evaporate into thin air. The value investor, however, doesn't sell simply because of a drop in price, but because of a fundamental change in the characteristics that made the stock attractive. The value investor knows that it takes research to determine if a low P/E and high earnings still exist.

3. Does that change affect your reasons for investing in the company?
After investigating how/if the company has changed, our value investor will find that the company is experiencing one of two possible situations: it either still has a low P/E and high earnings growth, or it no longer meets these criteria. If the company still meets the value investing criteria, the investor will hang on. In fact, s/he might actually purchase more stock because it is selling at such a discount.

With any other situation, such as high P/E and low earnings growth, the investor is likely to sell the stock, hopefully minimizing losses.

There's No Rule That Fits All
This approach can be applied by any investing style. A growth investor, for example, would simply have different criteria in evaluating the stock. It requires thinking and work on your part to ensure these guidelines maximize the effectiveness of your investing style. All investors are different, so there is no hard-and-fast selling rule which all investors should follow. Even with these differences, it is vital that all investors have some sort of exit strategy. This will greatly improve the odds that the investor will not end up holding worthless share certificates at the end of the day.

The point here is to think critically about selling. Know what your investing style is and then use that strategy to stay disciplined, keeping your emotions out of the market.

HAPPY INVESTING
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综合指数 2008年 12月 02日

如图中箭头A所示,综合指数虽然一度受到美国及区域股市暴跌的影响而开低,不过综指随后收复失地,只微跌了2.68点。综指当前的阻力水平仍然是处于887点的胜图自动费氏线,支持水平则是800点的胜图自动费氏线。

如图所示,布林频带(Bollinger Band)打开的幅度收窄至0%,这表示综指还是处于调整巩固的格局里,这也代表综指目前正在酝酿这一个新的趋势。接下来当布林频带开始明显的打开时,那综指的新趋势将会浮现,通常综指的新趋势将取决与届时综指处于布林中频带的相应位置。

如图中箭头B所示,成交量稍微减少2%,使到成交量继续的处于40天成交量移动平均线(VMA),这意味着投资者继续的对市场采取观望的态度,无论如何这情形在综指出现调整巩固时是正常的。

如图中C圈所示,平均乖离的振荡指标(MACD Histogram)还未出现期待中的圆底(Rounding Bottom),所以综指还是未能出现短期上扬的趋势,直到振荡指标确定形成一个圆底为止。

总的来说,综指目前始终是处于由T1及T2组成的下降趋势轨道(Descending Trend Channel)内,所以综指是首先必须先上扬突破此下降轨道,综指才有望出现上扬的趋势。

Composite Index Daily Technical Analysis 02/12/2008

Although the KLCI opened lower on Tuesday, as affected by the negative performance of the Dow Jones Industrial Average, it managed to regain most of the lost by closing only 2.68 points lower. Resistance for the KLCI remains at 887 Fibonacci Retracement while the support of 800 or 801 is still intact. (Study A)

As show on the chart, the Bollinger Bands Width expanded 0%, which suggests that the KLCI is likely to consolidate as the volatility of the KLCI does not increase. The contraction of the Bollinger Bands Width also implies that the KLCI is gearing up for a new movement, and the direction of the new movement shall be revealed once the Bollinger Bands Width re-expands.

As indicated by B, total market volume fell 2% on Tuesday, and therefore, the volume is still below the 40-day VMA level, suggesting the overall market is still lightly participated. But still, it is generally normal to have a relatively lower volume during the KLCI consolidation.
As circled at C, the MACD histogram has not formed a rounding bottom yet, which means that the KLCI is still moving on the weaker side, until the MACD histogram should tick up and form a rounding bottom.

In short, the T1 and T2 downtrend channel is still in place, which the KLCI is still trending down. Unless the KLCI could break away from the T1 downtrend line, the outlook for the KLCI is still bearish biased.

3 comments:

Rocky said...

Hi ZL,

GOOD one ... keep 'em coming.

Thank you 4ur kindness.

Kindness ... like a boomerang, always returns !!!

Ivan said...

Hi ZL,

Base on the chart below:
http://i456.photobucket.com/albums/qq281/xodiac88/DJIAPF.jpg

Would you mind to explain a bit ? How come you can read it and comfirm is bull ? 10q

Ivan said...

HI ZL,

Thank you for your posting on this before market open:

http://i456.photobucket.com/albums/qq281/xodiac88/klci03122008.gif

may I know why you did not using the MACD indicator for the above chart?

Thanks

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