“Knowing When To Sell”: Insights From Steve Cohen
Submitted by Nick Colas of DataTrek
We offer up everything we’ve learned about “Sell Discipline” over the last 30 years. Selling a position defines investment strategy just as much as what goes into a portfolio. It is also a critical aspect of attention management, especially when it comes to losers.
With the last few days of market volatility we’ve been thinking a lot about selling. No, we’re not changing our recommendations. We still like US large cap equities, even as we remain cautious about small caps, emerging market and EAFE stocks. If that sounds like a defensive posture, you’re right. As the old saying goes, “a hero is just a kind of sandwich”. And now is not a time for heroes….
Rather, our thoughts relate to how “Sell discipline” informs any investment process, and that is the subject of this week’s Story Time Thursday. Here is what draws us to the topic:
- The decision to sell pushes different mental buttons from buying a security.
- In many ways it is a purer test of investment discipline than what one chooses to buy.
- The rise of indexing makes for new challenges.
We will bucket this discussion into 3 points:
#1. The Trader’s Sell Mantra: “You can always buy it back”.
In my time at the old SAC Capital I heard this phrase more than any other. Meetings with the firm’s resident psychologist Ari Kiev often centered not on your winning trades but on those that had gone awry. Selling losers was every bit as important to the firm’s success as pushing your bets on winning positions.
Now, “sell when the tape says you’re wrong” is hard, especially if your investment approach is analytical. But the easiest way to trigger any trader into a meltdown is to say “the market has it wrong… this stock shouldn’t be going against us”.
But it took me years to understand the deeper value of selling to a trader: getting something off your sheet early is more about mental bandwidth management rather than just limiting losses. Losing positions have a way of sucking you into unproductive analysis and self-loathing. That time is much better spent looking for the next winning idea.
#2. The Investor’s Sell Philosophy: “What are my options?”
While longer term investors can learn a lot from the trader’s selling ethos, they are also playing a different game. Picking the exact entry point for a 5-10% move is not as relevant as sticking with positions that can offer 50-100% gains.
From watching hundreds of portfolio managers make sell decisions in my time as a sell side analyst covering the auto industry at First Boston/Credit Suisse I saw three consistently productive reasons for “Sell” decisions:
- The macro environment changes. The best call I have ever seen in 30 years was when a competitor of mine put a sell on every auto stock in 1994. His logic: these names don’t work when the Fed is raising interest rates. That was it… And he was absolutely right.
- Fundamentals change. Unexpected outcomes drive changes in asset prices. When a company’s strategy starts to falter, it’s time to sell.
- Something better comes along. A few years ago I saw a confidential study of long-short hedge fund returns that showed that position sizing was the primary cause of underperformance, not idea generation. Selling less-attractive stocks and owning more of higher-conviction names is the cheapest ticket to success.
#3: Our Approach: “Sell when you can, not when you have to”.
We got that drilled into our heads from an SAC trader who went by the name of “Booty” in the room because his first trade lost real money and everyone said he would get “the boot” as a result. Break trading’s cardinal rule of cutting losses early, and you get an embarrassing nickname…
It is a reminder that the best exit point is always when the market most agrees with you. That’s what makes selling so hard – it is essentially a contrarian action. Traders have it easier than longer-term investors, since they can always “buy it back”. But the best sell point is most often when everyone else wants to buy.
We will sneak in one more point before wrapping up: the growth in ETF-based index investing has added a new wrinkle to the discussion of “Sell discipline”:
- The packaging of popular investment themes like Growth, Value, Momentum and Industry Sector has pushed many ETF investors into unwitting concentrations that under a different structure would trigger “Sell” decisions.
- For example, Microsoft is well above the usual 5% prudent concentration limit in many popular ETFs such as the QQQs (11.4% weight) and Growth stock proxies like IWF (7.3%), VUG (8.5%) and IVW (8.0%).
- Financials are a large overweight in S&P 500 Value (22%), Russell 1000 Value (23%) and Russell 2000 Value (26%).
- Technology stocks are 36% of the MSCI Momentum Index.
Why that’s important: selling to maintain diversification is Investing 101, but in a world increasingly dominated by index-based investments it is harder to do. If the convenience of ETF investing has an Achilles heel, this is it.
Summing up with one final investment chestnut: “It’s not money until you sell”. Do that well and consistently, and you’ll never get the boot.