Why You Shouldn’t Fall in Love
Reminiscences of a Stock Operator
Cut Your Losses Short
Well, it’s happened again. Apple has blown by analysts’ expectations for the umpteenth time and the stock is getting another boost.
Apple managed this trick by selling way more iPhones than analysts expected it would. In fact, 8.75 million iPhones flew out of Apple stores, while professional Apple watchers had estimated that just a few more than seven million would be sold. That’s a 131% gain in sales from the same quarter last year. And these sales are coming even though everyone who’s paying attention knows that Apple will be bringing out a new iPhone model this summer!
Just to be fair to Apple’s other products, sales of iMacs, iPod Touch models and Apple desktops and laptops also kicked sand in analysts’ faces.
And the bottom line saw a 90% jump in profit. This translated to an immediate 5% pop in AAPL, the stock.
But I’m not writing about Apple’s earnings triumph to tout its stock. Even though I own an iPhone and an Apple laptop and an iMac, I don’t own any Apple stock.
My real topic is the joys and pitfalls of getting too close to a stock emotionally.
Even though I don’t own AAPL, I was very pleased to see that the company had scored a big beat. The part of me that revels in the “I’m a Mac … And I’m a PC” TV commercials gets a little thrill every time good news comes out about Apple.
And that’s a large part of the reason I don’t own the stock.
Loyalty is a great attribute in a dog or a friend, but it doesn’t have a place in growth investing. My loyalty to the Apple brand and the company’s excellent products would probably make me a little less willing to sell the stock in a timely way if it violated my sell discipline.
Since I’m a loyal kind of guy, I make it a point to avoid owning stocks to which I have an emotional connection. Selling is hard enough without trying to work against my own emotions.
Lots of investors have a related problem, which is that they get emotionally attached to almost every stock they own!
My theory is that some people have a high decision threshold when it comes to putting their money at risk. So in order to actually make an investment, they either have to minimize risk (by buying value stocks or using options to hedge the investment) or they have to force themselves to fall in love with a stock.
As any seasoned investor will tell you, falling in love with your stocks is about as good an idea as sending your bank account number over email to a highly placed African official who needs your help to get his millions of dollars safely out of a foreign account.
Earnings season is in full swing, which is kind of like the Lightning Round of a quiz show with much bigger gains and losses at stake. And for every triumphant AAPL you own, you also have a chance of holding a Research in Motion (RIMM), which reported disappointing earnings on March 31 and dipped from 75 to 68 in two days.
The general trend of the market is up right now, in spite of the big down days of the past week. And with the market on your side, your stocks should be doing well.
If your stocks aren’t acting right, or if they report earnings that don’t come up to scratch, you need to act to safeguard your capital. Don’t let loyalty or affection cloud your judgment. You buy stocks to make money. Hold them to it.
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When the Cabot editors who spend their days in our Salem office get asked for their favorite investment books, there are always a few new titles that come up.
But there are also a few titles that come up over and over again, and one of the most consistent is “Reminiscences of a Stock Operator” by Edwin Lefevre. First published in 1923, the book is a fictionalized biography of legendary trader Jesse Livermore.
Livermore was born in 1877, and began his career as a ticker boy in the bucket shops (businesses that took bets on stock prices, but didn’t actually buy or sell stocks) around Boston. With a true knack for remembering and making sense of stock prices, Livermore built a small stake and eventually moved to New York when the bucket shops stopped taking his business because he won too often.
I don’t want to summarize his whole life, but suffice it to say that he made and lost at least two major fortunes and ended his own life in 1940. Still, his net worth when he died was over $5 million, so he didn’t do too badly.
I keep referring to the narrator of the book as Jesse Livermore, even though the fictional hero of “Reminiscences of a Stock Operator” is named Larry Livingston. That’s because, as Livermore himself revealed, he had actually written the book with Edwin Lefevre acting as agent and writing coach.
Traders love the book for its insight into Livermore’s methods, but also for the drama of listening to a man narrating his own learning process. Like many legendary investors, Livermore both prospered and crashed in big ways, and when he crashed it was frequently because he strayed from his own principles.
One of his biggest busts came in a speculation on cotton, when he followed up a loss with further investments. By selling his winners he was able to hold up the price of cotton by himself, at least for a while. But when he ran out of capital, cotton plunged and he was essentially busted.
If there was ever an illustration of the principle that You Should Cut Your Losses Short, there it is.
For beginners in investing, “Reminiscences of a Stock Operator” is a very lively read and a tale of high-rolling speculation during some enormous market convulsions. The lessons the book teaches are just a bonus.
The habit of keeping a Watch List of interesting stocks is one habit of highly successful investors.
Personally, I also like to keep track of what’s going on with stocks that I have sold in the past, which is part of the “learning from your mistakes” theme of this Cabot Wealth Advisory.
When I sold Longtop Financial (LFT) from the Cabot China & Emerging Markets Report portfolio in July 2009, it couldn’t have been called a mistake. The stock was nearing the bottom of a decline that took it from a high of 30 in mid-June to a low of 22 in early July. Again, a reminder to always Cut Your Losses Short.
And I didn’t mind much that the stock got going again after a few months of consolidation.
The Story, Numbers and Chart (SNaC) approach to picking stocks requires that all three factors be strong. LFT is a good illustration of a stock that has a good story (the company sells software for financial ATMs, call centers and online banking) and good numbers (Q4 earnings were up 44% on a 66% gain in revenues, and after-tax profit margins were a whipping 46.3%). But its chart is only mediocre.
LFT peaked at 42 in January and built a nice base in February, but has shown only flashes of the kind of volume support that would indicate a strong change in investor sentiment toward it. Thus I’m happy to have my subscribers in other stocks … that are going up!
Presumably, fundamentals like Longtop’s will eventually begin to attract some serious money. When that happens, I’ll be ready to move it from my Watch List to my portfolio.
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Editor’s Note: Any idiot can learn from his own mistakes, but it takes a wise person to learn from the mistakes of others. When you subscribe to a publication like Cabot China & Emerging Markets Report, edited by Paul Goodwin, you are getting the benefit of 40 years of experience. The experience isn’t all Paul’s, it’s the accumulated wisdom of Cabot Heritage, which was founded 40 years ago. Through booms and busts, inflation and recession, Cabot has been learning–and teaching–the ins and outs of the market. I don’t believe there’s a thing that the market can do that would come as a surprise to our analysts; collectively, I think we’ve seen it all … at least twice.
Cabot China & Emerging Markets Report doesn’t have a lot of jargon or technical subtleties. When markets are going up, Paul recommends buying, and when markets go down, we retreat into cash. Good market timing and good stock picking have made the Cabot China & Emerging Markets Report the #1 rated investment newsletter over the past five years, according to the Hulbert Financial Digest.
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