Options Theory: The Market is Down, Should I Sell?
September 24, 2020
The market pullback has morphed into a correction, and you’re afraid it will soon become a bear market. In non-trader speak, that means -5% has become -10%, and you’re nervous we could quickly be -20%, or worse!
At the same time, you own some stocks that are sinking in value by the day. Your “losses” are growing, and the urge to abandon ship is mounting. CNBC isn’t helping matters. They’re running MARKETS IN TURMOIL segments complete with tales of looming recessions and other apocalyptic tales. So you email me.
“Tyler, I own some stocks, and I’m down $X. The market is falling because [insert scary headline]. It could get worse. Should I sell my stocks or stay the course?”
When Losses Attack
I get questions like this from time to time. Here is my answer.
First, I don’t give specific investment advice on how to manage your trades or portfolio. I teach, educate, and inform – all with the hope that you leave any class I moderate or blog I craft better equipped to make your own decisions.
You’re a pilot about to hop into the cockpit of a heretofore unknown spacecraft. It’s supposedly safe and has passed regulatory testing. But it’s possible that inclement weather or a mischievous fowl could come out of nowhere and down the plane. To prepare for the unlikely yet possible event, your commanding officer gives you a video to watch that explains exactly what you should do in the event of an emergency.
Do you watch it?
No. You’re busy watching Netflix. You’ll just call him over the radio for instructions while the plane’s going down. Yeah… Good plan!
Second, if you don’t know why you bought a stock in the first place, then it’s impossible to know when/if you should sell. Let me say that one more time. If you don’t know why you purchased a stock, then it’s not possible to know when/if you should sell it.
For example, let’s say one of the stocks you own is Apple. Why did you buy it? Was it a short-term swing trade, or was it a long-term investment? If it was the former, I’m assuming you have a stop loss in place – or at least a predetermined exit point. If it was a bull retracement pattern, then I’d put the stop below support. If Apple cracked support during the recent spill, then I’m out. My reason for entry (that it was a bullish pattern) is no longer valid, so ADIOS!
Maybe Apple was a long-term investment. Okay. Are you willing to own it through bear markets? No? Then it’s not a long-term investment! If you want to own something “long-term,” then you have to be willing to stomach the typical volatility that the asset goes through.
If you want to own stocks in a retirement account to participate in the long-term growth of equity prices over the next three decades, then you have to be willing to live through the inevitable bear markets that will arrive once to twice a decade. If you’re unwilling to see multiple temporary declines in your capital averaging around 30%, then you can’t be a passive stock investor.
If someone purchases 100 shares of AAPL @ $140 for $14,000, with the plan of owning it for the next decade, then I’m assuming they’re comfortable seeing their capital dwindle $4,200 (30%) to $7,000 (50%) during a major bear market. Furthermore, I’m assuming they’re comfortable making the bet that Apple will recover from all future downturns.
If they’re not, then failure awaits.
You and I are hardwired to buy high and sell low. Our emotions demand it. So how do we get around it? With rules-based investing. With a plan – thought out and well-understood before we ever get in the cockpit.
The March Massacre
I could leave it at that, but I want to add an example to drive the point home. I have a plan to accumulate shares of stocks every year. I want to grow an equity portfolio that provides access to the long-term growth of the best wealth-building asset on the planet. I don’t pick individual companies with this approach because A) I don’t need to and B) I’m then relying on my skill to generate the gains. To the extent possible, I want to eliminate discretion and skill from the process.
As mentioned above, I’m hardwired to make poor decisions when investing.
Instead of individual stocks, I buy broad baskets of the best companies on the planet. It’s the only way to guarantee you get what an asset class is designed to give. I’m talking about ETFs like VTI, SPY, IWM, QQQ, EEM, etc…
Buying an individual company isn’t so much investing as it is speculating.
I owned IWM during the March meltdown. It fell from $170.56 to $95.69. That’s a -44% horror show – effectively a swift halving of my position. So what, pray tell, did I do?
Nothing.
It was painful, annoying, distressful, depressing, and all the rest. But guess what? That’s exactly what I signed up for. It was unfortunate, but not unexpected. I suspect it will happen many more times over the lifetime of my investment. And I’ll grin and bear it. Because that’s the price we pay for the cash-beating, bond-beating, real-estate beating, precious-metals beating, superior long-term returns of stocks.
My portfolio is the servant of my plan. Absent a plan, my portfolio has no direction, no purpose.
To be clear: What kept me from puking in March was my plan. Without that, I’m sure I probably would have bailed at the worst possible price.
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Great content Tyler! That drawing made me laugh 😀
Thanks Tyler for drilling those principles in us. Plan the trade or investment.
I love the artistic Tyler without a plan puking.