The cold truth about walking away

In today’s Exponential Investor…

  • The hardest thing to do
  • The not so hypothetical
  • Take 4,150% gains in a few months

I’ve told the story a few times. The one about my introduction to stocks and investing.

The TL;DR (too long; didn’t read) version is my pop (grandfather) helped introduce me to stocks. Not loads, just little parcels here and there.

Not enough to make me minted by the time I left high school. But enough to help me fund a trip overseas.

I recall those days because it’s part of the foundation of what I do now. And along the journey when you start pretty young you learn about all the twists and turns that the investment game throws at you.

You see bull markets, bear markets, bubbles, crashes, you see weird and wonderful abnormalities on the market.

You also see things that are simply too good to be true, and at that cannot last forever.

In fact one of the hardest things in the world as an investor is to go against the grain not when things are bad… but when things are flying.

It’s easy to buy, hard to sell

I believe that as an investor, the hardest thing to do is to sell a position. At that, it’s even harder to sell a winning position.

Any time you have to sell a stock or an investment, it forces you to admit whether you’re right or wrong.

To admit you’re wrong is hard, but most people are capable of that. To admit you’re right, and then still to exit a position – I don’t believe most people are good at.

It all boils down to investor psychology and self-awareness… and a decent plan.

For example, let me put a hypothetical to you…

Let’s say you’ve been invested in a stock for the last year. Your rationale for that investment was this company has completely upended an industry and is potentially a market leader. Furthermore, it’s got a very strong first-mover advantage.

You invested in the stock and you were hoping that over the next year you’d make some pretty healthy gains. Maybe 50%; if a good year, 100%.

But what if that stock, one year later, were to have delivered to you 1,000%?

You invested £5,000 and then one year later your investment was worth £55,000.

That kind of return in a year is phenomenal, right? You bet. Some investors never see gains like that ever!

What do you now do?

You’re £50K in the black. Do you let it ride? Do you clip off your initial investment? Do you sell half? Do you take the whole lot off the table?

Be honest with yourself. What would you really do?

Step back and think

What did you decide?

Here’s the thing, that’s not really a hypothetical. That’s what the Tesla (NASDAQ:TSLA) stock price has done over the rolling year.

That kind of run over a year for any stock would make you seriously question how much further it can run. Is that kind of performance a true indicator of the value of the company? Or is it one of those fanciful market anomalies that you can move in of and out of with a big win and then a whole lot of sleep at night factor?

The other question is, if you stick around in it, what are you hoping to get out of it then? Another 1,000%? Or perhaps just a little bit more, a little bit more… a little bit more?

When you start to get into the kinds of returns that are truly eye-watering, you’ve got to continue to monitor your capital risk.

While you might have put a relatively small amount in, when you’re up there in the clouds, you have to now consider the downside risk if you fail to continue to be right, and end up being wrong.

Is an extra 30% or 50% worth the downside risk of losing 30% or 50%?

When you’re up in that echelon, it’s easy to get swept up in the very wrong idea that stocks always go up. It’s very comfortable to think that it will continue as it is. But nothing goes parabolic forever.

Markets are hot, crypto is hot, everything’s hot

Using Tesla as the example, it’s near a $500 billion company. It also has never made an annual profit. And it’s being outsold in a number of global markets by newer, more cost-effective and better-quality competitors.

If you’re looking at a company like that, ask yourself, is it a trillion-dollar company? Will its value double again from here? Or if you’re in the stock, ask yourself, has it been a good, lucrative ride and is it time to cash in the proverbial chips?

The same can be said for all kinds of stocks on markets around the world that have gone parabolic in a short space of time. Afterpay (ASX:APT) in Australia is what I call the “Tesla of the ASX”. In mid-March it was languishing at just over AU$8. On Monday you could have exited a position at AU$93 and a 1,061% gain.

There are even cryptocurrencies that have gone parabolic and exploded in a matter of weeks that you really have to consider, what is happening?

Yearn.finance (YFI) had a token value of about US$800 in late July, today it’s over US$34,000 – just a 4,150% return in a couple of months. Does that trend continue or would it be wise to reassess your capital risk in that position?

The point here is simple. When you win big, you can win really big in the stockmarket, in the crypto market, in any market.

But when you do win big, at what point do you tap out? What point do you roll those funds to another position to try win big on? How do you play your capital risk when you strike gold?

If you don’t know the answer to that question, figure it out. If you don’t have an exit plan, then you’re setting yourself up for potentially huge success that’s never released when things (eventually) turn against you.

Win big, exit big and if you’re not prepared to walk away from a position, you’re not prepared as an investor.

Regards,

Sam Volkering
Editor, Exponential Investor

Category: Commodities

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