Rule One: Don’t Do This When It Comes to Owning Stocks

By: Keith Kaplan

Aug 19, 2021 | EducationalInvesting Strategies

When it comes to buying and owning stocks, there is one rule you must follow:

Don’t fall in love with the companies you buy.

They won’t love you back.

Stocks move up and down based on fundamentals, technicals, and broader sentiment among investors. They don’t go up forever just because you want them to.

And — if stocks fall — they won’t rebound simply because you believe they will.

Today, I want to talk about a company that I fell in love with at one point. But more importantly, I know that I will have to let it go if and when it falls to $110.50.

It’s Common

It’s easy to fall in love with a company. It’s really hard to break up with one.

I don’t just mean this because you like what the company does or makes or produces.

When you put your hard-earned money into a company, you’re more than just financially invested. You’re a stakeholder in the future success of the business. And in the event that consumers turn to a competitor or stop buying your company’s products or services, you’re naturally going to question why.

It’s easy to blame someone else. Emotions can control us and blind us.

When we buy a stock and it falls 20% to 30%, our immediate thought is that the stock is going to bounce back. We fail to understand the opportunity cost that comes with waiting months or even years before a stock rebounds. And that rebound will only come if we are lucky.

Warren Buffett has said that investors should always be prepared to lose 50% of their money in the stock market. And if you think this is an exaggeration, pay very close attention to what happened last March when stocks plunged into the fastest bear market on record in a matter of weeks.

Falling In Love

One of the companies that I “fell in love with” in my career was Apple Inc. (AAPL). And there’s good reason to love this company. It is one of the most innovative organizations on the planet. Its iPhone dramatically changed the way that people communicate, listen to music, shop online, and engage with content. At a split-adjusted price, the stock traded at roughly $4 back in 2007. Today, it is north of $150, thanks to its robust sales and incredible market share. The company sold nearly 200 million phones in 2020.

It is owned by roughly 240 exchange-traded funds and represents more than 6% of the weight of the S&P 500 and more than 13% of the NASDAQ 100. Investors love this company.

But I have to be rational about this stock. If we look back at its history, the stock has had several sharp downturns due to bad quarters or broader market turbulence. Shares naturally pulled back during the dramatic sell-off during the onset of the COVID-19 crisis. Shares also tanked during the 2008 financial crisis, and in 2012 and 2015.

But we also saw a sharp downturn at the end of 2018, when the stock pulled back from the split-adjusted price north of $56 to the mid $30s.  I remember each downturn, especially that last one, very well. Because if the stock does push through the trailing stops that I follow on TradeSmith Finance, I follow the rules and sell.

On Nov. 12, 2018, AAPL’s health indicator within TradeSmith Finance turned red for the first time in more than two years when the stock dropped to $47.04. It was hard, but I sold all my shares the following day and watched as AAPL continued to fall to a bottom of $36.03. Following my exit plan and the TradeSmith indicators saved me a lot of pain.

Buying Back In

If you’re like me, you’re a buy-and-hold investor. But sometimes, there is a deep downturn in a stock, ETF, or broader market index. Given the stretched valuations in the market and concerns about a downturn, I’m always playing defense.

Trailing stops remove the emotion tied to a company. I might be in love with a company like Apple, but a trailing stop is like a good friend who is willing to do the dirty work and break up with the company on my behalf.

So I can tell you today with certainty, if AAPL falls below $110.50, I will sell the stock. That is the stock’s current trailing stop in TradeSmith Finance, based on the company’s custom volatility measurement within our system. Remember, every stock has different levels of historical volatility, so every company deserves a unique trailing stop based on its own data. I’m not just setting a hard 25% stop on a stock without understanding its history. Through TradeSmith Finance, I have various stops that have different ranges.

If the stock stops out, I will exit my position and wait for the signal to turn green again, which usually requires more institutional buying and broader support for the stock. This system  doesn’t try to pick the bottom. I let the tools offer a signal, and then I follow, in keeping with the strategy I’ve already determined is right for me.

I don’t like to be emotional about companies. I’ve learned my lesson the hard way. Instead, I just follow the signals and ride the wave. It helps me sleep better at night knowing that I’m protecting myself and my family’s money.

I’ll talk more about this concept tomorrow.

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