This blog is taken from my regular client newsletter. If you subscribe to our newsletter, it will be a familiar looking blog because I have duplicated much of the content here. I normally don’t do this, but I thought the topic worthy of ensuring the maximum number of readers get the message.
The hardest question I’m asked on BNN and the ValueTrend blog is “how do you know when to sell?”. The answer is hard to give because of the many different circumstances that might merit selling a position. Stocks tend to move much quicker when they begin to fall than when they are in an uptrend. The Wall Street adage “Stocks take the stairs up, and the elevator down” illustrates this tendency to decline at a faster pace than they ascend.
Here’s how ValueTrend utilizes a sell discipline to limit risk. Below, I use specific examples that were triggered in the ValueTrend Equity Model to illustrate six scenario’s.
Situation #1: Selling when the trend changes.
The ideal scenario to sell a stock is when one can identify the end of a trend. I wrote an Investors Digest article on the methodology behind identifying a potential decline here. There are often signs that a trend has changed from “up” to “down” on a stock, sector or even the broader market. As a stock or sector moves from a series of higher highs and higher lows to lower highs and lows, we will sell that position. As the article above mentions, we look for a few confirmations of this trend change before acting – lest we experience a “whipsaw” and watch the stock rally right back up again. Good recent examples of selling into a trend reversal are our exits from General Electric, Johnson Controls and AltaGas in the past.
Situation #2: Reducing exposure to an overbought market despite a rising trend.
Sometimes the market, or individual stocks become overbought. Despite their uptrends, they illustrate a parabolic (rapidly rising) price pattern that suggests a significant potential for a rapid decline. This summer, the extreme advances of the FANG & technology stocks inspired us to reduce our exposure to the sector from 3 stocks to one stock (Microsoft). In hindsight, the two stocks we sold (AMZN and GOOGL) went higher after we sold. Despite that move, it was the prudent thing to do. Historically, Investors have lost more money by sharp reversals in technology and biotechnology stocks than in any other sectors. Think of the 2001 tech bubble. Stocks like Nortel or even high quality stocks like Intel or Motorola rapidly imploded. Think of the implosion by Valeant pharmaceuticals and the entire biotech index in 2015. We felt our exposure was too high to this risky group of stocks that was (and is) aggressively overbought.
Situation #3: Selling to reduce exposure
The ValueTrend system dictates a price position between 2% to 7% per stock, and a maximum position of 10% in an index or sector ETF. It is rare to see us hold 7% of the model in one stock. In fact, we typically peel back (sell) some of a stock if it has risen enough to reach 7%. MasterCard is a recent example of a stock that started at a 5% weighting. It outperformed in such a rapid manner that it began to approach our 7% ceiling. We sold enough to bring the stock back to 5%. Another example of selling to reduce exposure was our decision to sell about half of our US stock holdings in the spring of 2017. While our remaining US stocks were negatively affected by the rise of the loonie, our exposure to this currency drawdown was reduced.
Situation #4: Greener grass
There may be nothing wrong with a stock. We may simply foresee less upside going forward on than we have experienced up until now. Sometimes we will continue to hold a high dividend stock in the Income Model but sell it in the Equity Model. We’d rather put the capital to work in higher growth stocks within the Equity Model, or hold the cash if markets appear risky. Good examples of sold stocks that looked less growth orientated than the Equity Model demands include past sells of CP Rail, and JetBlue. These are good companies that we made a bit of money on- and we would indeed re-enter the positions within the Equity Model should their growth outlook improve.
Situation #5: Cyclical or trading range patterns
Sometimes we buy stocks or sector ETF’s that trade in a range. For example, BCE has recently been moving between $57 to $62, and we have traded it twice within that range. Mondelez is a stock that seems to be stuck between $40 – $46. We own it now, and look to sell it as it reaches $46.
Sometimes, seasonal tendencies tend to dictate that certain sectors do better at one point of the year than others. For example, consumer staples tend to be stronger over the summer months. Consumer discretionary stocks tend to be stronger during the winter. While this rotation in strength isn’t always the case, it happens often enough to inspire us to seasonally trade the respective sector ETF’s that represent those sectors. Same goes with energy stocks, which tend to have their greatest strength from early in the New Year until the spring.
Scenario # 6: Yikes away!
There are times where a company will issue a surprise financial report or negative news of some sort. Traders react quickly and aggressively to dump the stock, which in turn causes a landslide stock price movement. A recent example of this is Cineplex –a stock where we had initiated a smaller 3% position in the Equity Model. The company announced lower than expected earnings and guidance in the late summer, and traders punished the stock by marking the share price down by 20% within a few days, breaking well below technical support. After such a selloff, one has to decide whether the market has over reacted and an oversold rebound is likely – or if it is best just to sell with the crowd. In such situations, there are no hard and fast rules. In Cineplex’s case, we held out with the expectation that the winter’s movie lineup (including the new Star Wars, and others) might rally the stock. This has not taken place in the manner we anticipated. The company continues to be a well-run business, however the stock is trading with significant skepticism surrounding future box office revenue. We are selling.
Next blog: Ask me anything.
I ran a couple of blogs in the summer where readers could post a question – and I would select those questions that looked suitable for a blog topic. Here are the links to the last two “Ask me anything” blogs:
I’m opening the floor to post new questions for an upcoming “Ask me anything” blog. Please post your questions in the comments section below, and I’ll do my best to address them in a new blog.
Hi Keith, I’d be interested in your take on XLY. On a 1 yr it seems to my novice eye to have developed a bit of a spike and moving outside what is maybe a channel. Not much, but again I’m a novice. I’d appreciate your views. Thanks!
XLY (discretionary sector) is in seasonal favor right now–we own the ETF in the equity model. And yes, like the broad S&P 500 itself, it is moving parabolically. So one is torn between selling into the madness, or playing out the rest of the seasonal period of strength. We are playing out the seasonals–ie more likely to sell in the spring (which in our mind is sell anywhere from April to end of May).
Meanwhile–watch XLP–the staples–it needs to break out of its holding pattern. That will be a likely rotational candidate if as when the high beta stuff rounds over. Plus the seasonals come into play in the spring…we shall see how it plays out I guess.
I just got off the phone with Brooke Thackray – who manages HAC and is a seasonal expert. We agreed that most patterns that normally appear on markets are not happening right now. So a parabolic move with overbought momentum indicators has not been followed up by a correction. We decided that this condition will eventually end, but its hard to say when. It ain’t over til its over…
If you look at longer term monthly charts of the S&P and the Dow those charts are parabolic (trendling much greater than 45%) since early 2016. The steepness is even much greater than the Dot com advance. Based on that I am moving to much more defensive positions. Not selling everything buy starting to scale back to cash and probably bonds.
Yes, Dave, totally agree–I’ve noted that observation on this blog a few times –that, and the unprecedented lack of volatility. Not sure if you read it, but you might find this blog interesting–I note the patterns on markets following low-vol periods: https://www.valuetrend.ca/how-quickly-we-forget/
Hi Keith, Thanks for the sell blog…all great stuff. What I’d be interested in knowing pertains to rules you use regarding buy initiation upon a breakout. For example looking at a reverse head and shoulders pattern, I understand that you initiate a 1/2 position once it breaks the neckline (of course waiting the 3 weeks) and then add two 1/4 positions each time it retreats to the 50 day MA …..but from that Reverse head and shoulders, do you then use the head low ( of the head and shoulders pattern) to determine the next uptrend line? This question stems from the fact that I find that the head low (which is often a capitulation) often skews the new uptrend line to being too steep and that the following uptrend lows do not seem to line up with the head low. I get bumped out of stocks by misinterpreting the new uptrend line despite waiting the 3 weeks……Thanks for your help!
Thanks for the comment Christopher
When I buy, I dont necessarily buy in increments as you suggest. And I even will sometimes buy off of a daily chart (3 + days, vs 3+ weeks for confirmation) but that depends on the formation. For example, triangles are typically formed over long periods of time–so i certainly use the 3 week rule there. But the head and shoulder pattern can often be shorter in nature, so I like to wait a few days, usually more than 3 but less than 3 weeks–see if it holds, see if it tests the neckline, then buy. I might just take my entire position (3-5% is normal for us) all at once, or do it in 2 steps . The measurement from the head of a H&S pattern is not to determine a trendline as much as it is to estimate the potential upside. Such measurements are based on the theory that if the market sold it off that much from the neckline before, that same volatility could reappear to the upside to give an equal move up. The angle of ascent that you are referring to can be determined only after 3 successive lows and highs. Having said that–the 200 day MA might support the stock as it moves out of the H&S base.
Phew–that’s a lot to absorb, but hopefully it makes some sense
Wow, thanks for taking the time to explain that Keith!….clears up major questions
in my trading! Cheers
Read my book Sideways Chris–I think it would be of great help in your development in a trading strategy
Good Morning Keith,
You mention that you sell stocks when you are overweight on a particular company. Once you sold the portion to balance your portfolio, what do you do with the money if you are holding 20 companies in your portfolio?
Hold the cash, wait for another opportunity.
A few weeks ago one of your blogs discussed the Canadian Materials sector. In it you referenced POT and AGU stocks. These companies have merged to form Nutrien (NTR) on the $TSX. Wondering what you think of it and the Canadian Materials now. The reason I ask, is that the $USD has broken support from 2016 and now has an even lower low breaking the $91 support from Sept 2017. It is only in the 2nd week of the break down, so it can still rally. However if it doesn’t rally soon, this could be suggesting a breakdown in the $USD which could mean a new longer term run in commodities. The $CRB chart (I realize it’s mostly oil) is sitting right at resistance on the weekly chart and is interesting to watch. Maybe you could do a blog on this.
Good idea – thanks Ron
It’s interesting that you illustrate weekly charts in this blog. Do you trade on weeklies or do you go to dailies for confirmation?
I like weekly charts but I tend to be a longer term investor. As a market timer, I don’t seem to have the psychology and got my butt handed to me too often.
I also liked your comments on allocations. I just completed a re-balancing and hold nothing in excess of about 5.5%.
Fred–I use the weekly chart with the 40 week SMA to determine the trend. The daily helps me refine entry exit points with both shorter termed patterns and the various oscillators I like to look at such as RSI, MACD, Stochastics, moneyflow, etc
I enjoyed reading “The Art & Science of Selling”. It is great refetence material. I’ve always believed that it’s when you sell that counts.
However, buying is also important. Would you be kind enough to do a dedicated article on the art science of BUYING. Do you subscribe to a ‘margin of safety’…or ‘follow the trend/seasonality’, or buy high, sell higher. Please address these sometimes conflicting views in your article.
OK thanks Mark–I have covered it in Investors Digest articles and on this page of the website: https://www.valuetrend.ca/our-approach-portfolio-management-strategies/
However its probably worthy of a revisit for a blog idea–thanks!
Great article, really enjoy reading your blog. Keep up the good work!
I have a question for the “ask me anything” blog. When a company is inter listed on the TSX and a US exchange, which chart is more relevant to perform technical analysis on? Would it be the listing that tends to have more volume each day, the listing in the county where most of income is derived from or some other factors?
Thanks so much for your regular blog posts. I have learned so much over the years!
thats a good one–I will address this question in the blog–thanks Josh
HI Keith, you mentioned BCE in the trading range category. Do you see it continuing to trade in this range? And seeing that it is at the lower end of the range, a good entry point?
We sold BCE in the ValueTrend equity platform. However, we kept it in the income platform. Technically the stock has been range bound from about $57-$63 for some time, as noted. However, to buy it back in the equity account – there must be a catalyst to drive it back up to $63. The reason BCE fell so hard from its $63 top was that it is interest rate sensitive (to the negative)–debt costs more money when rates rise, and they finance a lot. We don’t see any catalyst to drive it back up in the next 6 months. Thus, we are not buying it or any telecom back for the equity platform right now. The income platform will continue to hold it for its 5% dividend. Downside on the stock is likely right at the $57 level. Next support is $55 it that fails. So there isn’t tons of downside from here, or much reason to sell it for income investors. Its just not likely a good play for those of us seeking more than a 5% return over the next year.