Attacking Conventional Wisdom - Part I

Sitting idly in California while the East Coast braces for Hurricane Sandy, I’m taking advantage of the surprise day off to study markets, strategy and discipline.

I’m also free to share a bit of thinking, so let’s attack some conventional wisdom…

You’ll never go broke by taking a profit

I mentioned on the stream a couple weeks ago not to buy into the oft-uttered notion you will never go broke by taking a profit. Guess what - you’ll never really get ahead either.

The reason - you need big winners to post big years in a portfolio. As years progress then, it’s the big winners which ultimately change lives.

Study past results - I can assure you your best years had big winning positions. Yes, there are day-traders who can push back 14 caramel colored cans of fructose every session and pound their way to 100%+ gains. But you’re not one of them. The percentage of traders who manage this consistently is very small, their age is very young, and their duration of success is short-lived (try it for a few years and see if you can stand-up straight).

For the rest of us, that natural tendency to take profits when you have them is costly, since it is generally met with an equally natural reluctance to take uncomfortable losses. While this post is more about managing profits, you must protect against losses, certainly.

It feels good to take a profit. But It doesn’t take a math genius to calculate where you’re headed when you harvest gains quickly, yet hesitate to book loses. If you’re sufficiently disciplined, you might squeak-out uninspiring net-gains in the end, heroic trader that you are. But you’re fighting a constant state of erosion (spreads, commissions, the important fact that stocks break-down more rapidly than they rise, etc.). You’re working against the grain, much too hard, just to feel good about being an idiot.

This is not to say you cannot trade around positions (lighten-up when a stock is extended, or as a market environment weakens; add-back at an area of potential support, or in an improving environment). William O’Neil will still kick your ass in the end, as he holds onto a CSCO throughout the 90’s, adding-only at progressively higher prices as the stock set-up fresh buy entries; then selling the entire fortune only after the name finally broke-down on major volume - some 10 years and close to 10,000% higher from the initial buys.

Take some off, that’s fine. We’re not Bill O’Neil and it’s not the 1990’s. Trading around a position (varying a position’s size while a name ebbs and flows higher) can work to your advantage. I’m not recommending this, necessarily. It’s too easy to screw-up (paring-back just before a fresh breakout, beefing-up ahead of a sharper reaction, whipsawing yourself into frothy pulp, etc.). Just be sure to allow for big winners as they emerge, however you manage it.

And since markets do not always trend, you have to work with what the market gives you. Be patient, as opportunity eventually reappears (typically after you’ve convinced yourself not to expect a major move). And ask yourself this - in your investing career, have you not been repeatedly surprised by the duration of a market or stock’s trend?


That is the important point - when markets are trending there exists the potential to trend further than you expect (a good reason to reign-in those many predictions and expectations). And taking small profits regularly, because it feels good and you’ll never go broke, means you’re eliminating yourself from all the greatest trends - the trends that change lives.

If it sounds like I might be lecturing to myself, perhaps I am. I could do better at this, and this year in particular. So apologies for using you as a sounding board in an effort to tighten-up my discipline. I’m looking to hold to my better principles by sharing them aloud. Or, as Downtown Josh Brown referenced Friday night in uptown Coronado - I write in order to know what I think

More on attacking conventional wisdom later - East Coast stay safe!