Take Sell signals? Or be contrarian and Hold?

Two questions were asked of me last week by a relatively new member, Richard V.

Richard has provided his permission to post his questions and my replies as it will hopefully be helpful to others…

As with the 2008 dip which was caused by financial over borrowing and the level of options trading, the current market movements have been much slower as there is more sophistication in the purchase of options and a prolonged war creating longer uncertainty.

How this fits in with our current market position is still unknown but as you have pointed out we are now at a significant retracement. Any further retracement would make our companies a cheap purchase. Given this should we be selling our shares if there is a sell signal or should this be a time to be contrarian to our rules and continue to hold stocks that are now cheap?

We would still receive good dividends in the short term and at some stage the market will reverse and we will recover our paper losses on these stocks.

[GS] If you have decided to apportion some of your investible capital to an Investment Plan that calls you to be ‘mechanical’ (objective & consistent decision-making), then you should always follow the rules written into that pre-decided Investment Plan.

Then, being committed to that Plan is how you remain objective in the moment rather than being swayed be the winds of outside influence, “noise” and self-indecision. Let’s look at both sides of your question:

  1. Fact: yes, the markets are in a significant retracement. There is NO evidence that this retracement has ended. This is the case for selling when ‘mechanical’ sell signals occur.
  2. Fact: yes, so many stocks are ‘cheap’. And at some stage may be higher than their current prices. This is the case for being contrarian and NOT adhering to sell signals.

They are both correct. I guess you are asking yourself (and me) which is the more correct RIGHT NOW?

Answer: I don’t know. And according to Mark Douglas’s 2nd Fundamental Truth of actively investing in the markets: “You don’t need to know what will happen next in order to make money in the markets.”

This is why we so heavily insist on writing an Investment Plan (IP) before market conditions such as these occur, a Plan that stipulates what actions you will take regardless of whatever market conditions happen, up or down.

Is the IP ever subject to change? Absolutely. But only based on research that provides evidence to make the change.

I am enjoying the short time I have been with SWS but also believe that market rules should be different for different market conditions, rising markets are easy, falling markets need an extra sell position and the current low market prices should also see additions buy and sell rules that reflect the external market forces which will be different for each event that triggers the change. I just do not know how to make the adjustment and when!!

[GS] That’s what we are here for.

This is precisely the problem that we are researching to solve at Share Wealth Systems, viz, systematically reduce portfolio drawdown during a longer slower declining gradient market (slower compared to Jan – Mar 2000, Oct – Dec 2018, Oct 2007 – Mar 2009). Without reducing performance during rising markets.

Myself and part of my team have already invested a few 100 hours into researching a solution to this problem.

I have spoken in my last 2 C&G webinars about the areas on which we are focussing our attention. My research is nearing completion on the one front, finding a trade entry filter that reduces the number of entries that lead to loss trades, while not also filtering out the trade entries that lead to profit trades, and especially large profit trades.

While not yet complete, the research is showing that every idea used so far (mine and other documented concepts which I have tested in the past and have retested again under these market conditions), slightly improves, slightly reduces or greatly reduces the current ‘edge’.

Indeed, even the concepts with slight improvements in the edge have other issues that bring into question whether any change is merited. For instance, far less signalled trade entries which reduces overall portfolio exposure, which in turn reduces long term annualised returns. And filtering out large profitable trends, a cost of also filtering out smaller losing trends. I could go on…

It’s all probabilities and degrees of… Ultimately the statistical ‘edge’ over a large sample of trades over multiple market conditions (not just the last year or so) is what we objectively use to make a decision on which rules to use to define the ‘edge’.

These last few paras deal with ‘method’ research at the trading system level, which defines when to buy and when to sell if we could take EVERY trade. Which we can’t do, so we also research at the portfolio level, where a subset of all the possible entries are traded. This is the other area we have been researching. This research uses Money Management (position sizing) to manage overall risk. And Risk Management, which uses external conditions to the trading system itself to manage risk.

I hope to bring the outcomes of this research to a head in the near future at which time I will do a detailed webinar on our fundings. Any changes will be documented in the Public Portfolios Investment Plans and followed by the Public Portfolio from then onwards.