My name is Anders Bøgebeck. My mission is to help you become a better investor and trader. Why is this important? We are not only helping ourselves by becoming financially free. Along the way we help society by either allocating capital the right places or creating better products and services. That's why I want to help you achieve the life you desire!
Have you heard the pro fundamentalists talk about, that "in the long run, it's best to hold on to your stock". This implies, that if you have picked a great company, then you should never sell your position, because it is always best to hold on to it. In this post, I will walk through, why I believe this is not the best strategy and what one should do. I will discuss:
1. Market psychology
The stock market is driven by greed and fear, i.e. human action. It can seem very irrational at some point. Very overbought or very oversold. That is why it tends to move in cycles. This is not to confuse with the actual business cycle in the "real" economy. The "greed" cycle is about people buying hoping the stock to go up. The "fear" cycle is when everybody rushes to the trading platform to sell, typically because of some bad market news coming out. If you don't buy into the fear cycle and sell into the greed cycle, you will have a very hard time making money. As Warren Buffet famously states: "Be greedy when others are fearful and fearful when others are greedy". When everybody shouts "buy", you should be thinking about selling.
2. The effects of compounding - time value of money
As can be seen in picture 1, if you bought into the greedy cycle in 2017 and panic sold your stock in the crash in 2020, you would have made zero from your position (assuming you had a well-diversified portfolio of quality stocks). Alternatively, you could have made a lot by following this basic principle. By buying and selling more often, you will enjoy the effects of compounding. Which is more money making more money. To be honest, if you want significant gains, you need a great percentage gain of the total dollar value of your portfolio - every year!
3. Risk management
You cannot allow any single position in your portfolio to go too much against you. It could literally destroy your hard earned money. Therefore, you HAVE to place a stop loss. But by doing so, you would be stopped out of many positions when the market crashes and you will be at zero or a loss again (assuming you bought into the greed cycle). Again, this states the importance of buying into fear.
4. The stock market is not the real economy
Don't think for a second that you can say the stock market is the same as the real economy. Rather, it is about liquidity. This means: what makes people push or pull money from it? For example, if there is a banking crisis, this typically makes people pull money from the stock market. This is because people need to sell at any price to leave a big house and a nice car, which they actually couldn't afford.
Well, what makes people put money back into the stock market? You can be pretty certain, that capital will flow back into the stock market, if it has no place else to go. This is typically seen as the rotation big pension funds and investment banks make from bonds to stocks or from cash to stocks. It happens because bonds or cash do not seem as a good investment at that moment. This could happen after a crash, when smart money buys.
Demographics can also affect the stock market a lot. If there is a bigger percentage of people moving into retirement age in a society, they need to sell their portfolio to afford senior life.
To showcase the disconnection from the real economy, check out the market cap/GDP index in picture 2, which is the best measure of the size of the stock market relative to the real economy. It has always been pretty far off.
5. Your stock is a derivative of the company you buy
When you buy a public stock you are buying a piece of ownership of the company. However, this doesn't mean that the price will always follow the financial strength of the company. You as an anonymous person do not decide, what should happen with the profits and how the company should reinvest the profits. Therefore, it is like a derivative of the actual company. Likewise an option is a derivative of a stock. Whenever you take the derivative of something it also tends to become increasingly volatile.
6. Does the stock market always go up?
You may have heard the phrase, that the stock market always goes up. And yes, the S&P500 has always gone up. But for what timeframe? Check out picture 3, which is a monthly chart of the S&P500. The crash at the Great Depression was huge and it actually took 24 years for the index to recover. If you held on to the stock, you would have made no profits in this whole period and even longer, when accouting for inflation. Let's not even talk about the Nikkei 225 Index, the Japanese stock market, which has not recovered for 30 years! However, by buying low and selling high, you could have made significant gains even after the Great Depression.
7. Take away
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