Ask Colin

At the end of a bull market, why sell the stocks with the least gain first?

The detailed question was:

In your  strategy for getting out of the market, you say you sort your holdings in descending order by percentage gain on cost. This is logical if you bought them early in the bull market, as you do, but if they were bought well through the run, as many of mine are, would it not be better to sort them according to percentage gain from their price as it was near the beginning of the bull market?

You are not correct that I have bought all my holdings early in the bull market. The reality is that many that I bought then will have failed and been replaced. Others might have shaken me out of the trend, but I bought them back later when the trend resumed. In the ideal situation I would be a brilliant stock picker and bought the lot at the start of the bull market and still hold them all. Unfortunately, I am only human and it is in the nature of investing that most holdings show mediocre gains and losses. About a fifth will make the real money. It is important to let these run as long as their trends persist, subject only to my tactic of taking profits progressively in the absolutely outstanding ones.

Even if I had bought all my shares only a month ago, if my market exposure strategy indicated a reduction in exposure, I would first sell any on which I have not yet made a profit. The logic to this is simple. If I am reducing exposure because I think the risk is high that the bull market could end, any share that is not making a profit in my portfolio is probably a dog and should go first. Most people find it difficult to take losses, so they take profits. This is the wrong thing to do. We want to ride profits and cut losses, not the reverse. My discipline, then is to cut losing holdings first. Remember, you can buy them back later if the situation changes. Nothing is final, the market keeps operating continuously.

After the losing holdings are gone, if I need to reduce further, I sell the least successful ones first. If I have to choose between winners, I want to keep riding the best ones, not the weaker ones. This is a variation on the idea that it is tempting to lock in profits by taking them early and letting weaker ones run. If you were allowed to switch bets on runners during a race, would you move bets from the leaders to the ones falling back, or from the laggards to the ones moving up in the field?

I know the point you are making is that it depends on how long the share has been held as to how much profit it could build up. However, the best stocks are the ones which start running earlier in the bull market. If I have a choice between selling a stock held for two years with a 50% gain and a stock held for two months with a 5% gain, I will always sell the second one. If it started later, it is to be preferred less that the one that started earlier. If I bought it towards the top of a great run, I may be buying it too late anyway.

I will not deny that this is an arbitrary approach. It is mechanical for the simple reason that we all have a strong tendency to take profits rather than sell losers.

Do you have to do what I do? No, most definitely not. My investment plan is what suits my temperament and objectives. Your investment plan should be different, to suit your temperament and objectives. In my book I tell you that you should only use my plan as a model for what should be in your plan, not slavishly follow me. The reason I wrote the book was to show what a plan might look like and to explain why my plan was as it is.

So, since your email indicates that you are uncomfortable with following me, you need to think out carefully what is right for you. Make sure you are not simply being pulled toward the tendency to sell winners and hold losers. If you are sure you are not, then you need to work out another method of assessing which ones to sell. For example, your argument that you should take each of your holdings back to the start of the bull market in March 2003 and work out the price gain since then is a good one. You could use this as your method. You could sell the worst ones and keep the best ones. I am not suggesting you do this, merely trying to get you thinking. Another possibility is to use Dr Elder’s greater fool theory and sell the ones that are trending up and currently most stretched above their moving average. Again, I am not suggesting you do this, merely trying to get you thinking. Maybe you could incorporate both of these ideas into your final decision. There are infinite possibilities, none absolutely wrong or right. You need to work out what makes sense in terms of the issues and is sufficiently comfortable for you to be able to follow your plan. Only you can work out what you should do.

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