Attacking Conventional Wisdom - Part II
From over the weekend in IBD, the point was made - Big, winning stocks will sometimes retest buy-points before a major run higher.
The article is useful, true and worth a read, but, I was reminded of another conventional wisdom...
Never let a winning trade turn into a loser - Ever!
Okay, this well-intentioned axiom has partial merit, especially if you’re day-trading. Widow, orphans and even you have to protect against losses. I'll never mock that - you'll be crushed. But the half-baked notion you cannot let a position where you have a gain drop back through your entry price is wrong on too many levels. Let’s rip into it.
Markets don’t care what coffee you drink and certainly not what prices you’ve paid. It’s not about you - ever! If you buy a stock and it goes up, keep your head about it. Are you good on the chart? Were you ever good? In many cases, you bought wrong and you’re still wrong. Long and wrong - pour another cup and sell that nag.
But what if it’s a higher-beta, leadership stock and you’re hit with a typical 5% market reaction; some insider selling; an analyst downgrade based on valuation (my favorite); a secondary offering just announced; a nuclear event; hurricane - an article in Barron's!
What if?
You’ve got to measure performance in a position relative to itself and the world which surrounds it. Your entry price, in and of itself, is insignificant. Granted, if you bought at a level of specific support, the price paid might then be relevant (settle down), but not because it's your entry.
Let’s say, oddly, Magic Johnson announces he’s HIV positive and you are long a couple of Biotech stocks (true story). The next morning, besides you feeling schmucky, the group is sharply higher. All but one. This holding is up only fractionally, and on heavy volume. Not only that, the company has an AIDS drug in development and that's about it for their pipeline.
Thanks pal - for holding that bag.
[Immune Response was a high-priced, small biotech in the early 90's. Shortly after, it would fall sharply; ultimately, it died a slow death; Magic is still going strong]
Or try this - you paid an average of $118 for a LNKD (also true; chart below) early this month (October), because A): it was a leading stock within a leading industry group. B): the name was attempting to breakout to new highs following its constructive 17-week base. And C: it fit the criteria whereby newer-winning-liquid-institutional stocks typically outperform to a higher degree in the 4th quarter. Very good. Soon after, at 122, the stock looks fabulous still and the coffee is hot, right?
But the name stalls now and begins to decline. And, leader that it is, this precedes a reaction in the overall market (something to pay attention to). If you were being exceptionally careful because you were either bearish on the market, or else over-exposed long, I can understand selling this name near the close of October 5th (118.83); it breached its 20-day moving average (MA) on modest, yet rising volume. If you are holding a working, healthy position in a not-over-exposed portfolio though, what is the point of selling just because it went through your 118 entry? An entry is only rarely perfect -that was a good entry (the reason: the biggest of winners usually do not hand-out invitations for you to get aboard late - it's okay to pay-up some for quality).
Indeed, there is nothing really wrong with this chart until the end of October 12th, when it closes below its 50-day MA on strong, rising volume (110.41). Now you can be stopped. Now you can complain.
While I'm not convinced LNKD is truly breaking down, I respect and understand exiting or reducing the position October 12th and shifting more defensive. Again, guarding against serious loss is exceptionally important. We’re down 6.4% now in this example - volatile or not, it's enough to hurt.
LNKD will report earnings this Thursday, after the close. I’m out of the position, presently, licking that sticky wound. But even though LNKD is lower still (closing Friday at 104.55), being out of the name has never felt quite right to me. Perhaps we’re about to see it, perhaps another conventional idea of avoiding 200+ PE stocks will re-render itself useful. Or, perhaps we’ll see why this chart was so strong and lovely in the first place.
Either way, entry price be damned. You may have bought LNKD only Friday and you’re holding a winner, but come Thursday night your printed onto Friday’s lunch, as that winning trade cuts like gapped teeth through hopeless island-stops.
Sell for a reason, and make it a good one - not because the horse you rode in on sports the #7.
Quicknote - if you see me scale-back into an initial speck of LNKD before Thursday’s numbers, don’t do what I do; at least not because I’m doing it. I’m a professional and I’m trained in how to crash. I live in padded rooms and I wear Buster Posey helmets. So cut my teeth!
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