When We Should Buy, Sell, or Hold Our Stocks?

One of techniques/strategies in stock investing is related to how to manage the portfolio  every some time in order to be back to be 'in order’ after it was 'messy' before, by removing unproductive stocks/stocks are tend to down, holding stocks that still has the potential to rise further, and buy new stocks to replace the sold ones. The term for such strategy is the portfolio re-balancing. Portfolio rebalancing is very important to do, whether you are a long term investor, or even a daily stock trader.

The analogy of portfolio rebalancing is like in football competition. Each year, the manager of a club have the opportunity (when the transfer window opens in the beginning and the middle of season) to buy the players he needs, retaining some of the existing players, and sell/release players that are no longer needed by the team. Buying and selling of players is necessary because even an extraordinary footballer, in the end he will grew old and lose his ability, so he is no longer able to contribute to the team. On the other hand, there will always be talented young players that could be taken by the club to strengthen the team, to replace the one who is no longer able to contribute.

Apart from the issue of age, there are many more reasons for a club to sell its players, such because: 1. The player was not able to play as expected, or his playing style does not fit with the style of the team as a whole (if this happened, the selling price of the player will be lower than the purchase price), 2. The player has a temperamental nature, or other issues, and 3. There is a bid from other club to buy him at exorbitant prices.

When the club maintains a player/does not sell him, there is only one reason: The player is expected to contribute more to the team. Even though there are other clubs who were after him, but the bid prices are not high enough compared to the expected contribution from the player.

Meanwhile, when a club will buy a player, the reason could be because: 1. The price is relatively low compared to the quality of the player itself, 2. The price is low, and it was accordingly to the quality of the player, but he is match the needs of the team or the manager, 3. He’s a talented young player with bright future, and 4. Although the price is high, but it worth the outstanding quality of the player.

And now, believe it or not, in formulating the composition of the stock portfolio, your job as an investor is like a football club manager, and the stocks that you hold are like the football players. So why do you have to sell one or more shares you hold? Well, it's probably because: 1. When you buy a particular stock, the reason was because the performance/ fundamental of the company is fairly good, but the company was not able to maintain the good performance in the next period (eg the earnings suddenly dropped drastically, or even suffer a loss), 2. The share prices are often moving wildly without obvious cause, thereby disrupting the overall portfolio performance, and 3. At a certain point, such as when the market was bullish, the stock price has risen so high compared with the fundamental development of the company itself, that makes it to be overvalue.

If you notice the three points of 'reason' above, you’d see that you can sell your shares in a position of making profit, loss, or the middle. So the reason of why you have to sell one of your stocks is not because you had some gains or losses from it, but because you have to sell it. No matter how severe your losses, but if the stock was likely to dropped further, you must sell it immediately. Conversely, although you might be 'in love' on a particular stock because it has gave you so much profit that you are determined to hold it forever, but when 'the time comes', you should sell it anyway. Even for a stock like Astra International (ASII), if you kept it from 2011 to 2013, then you’d lose the precious two years without gaining anything, because ASII movement was stagnant during that period of time, in accordance with the stagnant financial performance due to the weakening prices of crude palm oil and coal at the time.

Then why you can hold the other stocks? That is because these stocks, after you analyze them once more, still has the potential to rise, although it would take time. It is ridiculous if you keep holding one of your stocks because ‘The loss is already too much, better wait the price to rise a bit then I will sell it'. The question is, if the fundamental/financial performance of the company itself was already in shambles, then how can the shares to go up?

And when you intend to buy certain stocks (in lieu of the holdings that have been sold previously), then some plausible reasons are: 1. The valuation is relatively undervalue for a good stock (this usually only happens when the market/Jakarta Composite Index was in bearish period), 2. The valuation is very undervalue, and the fundamental of the stock was not that bad, 3. The shares representing a small company that is likely to grow up to be big one day, and 4. Although the price is relatively high, but it was quite commensurate with the company's ability to make substantial and consistent profit from year to year.

So believe it or not, if people like Carlo Ancelotti, Jose Mourinho, and Josep Guardiola invest in stocks, all of them would use the strategy of value investing, ie buying stocks based on the fundamentals and valuations. Now try to imagine if these football managers buy particular football players based of rumors that he was a great player blah blah blah, without investigating/analyzing the player first, and without considering whether the price is fairly reasonable or not. What were the results?

Unfortunately, there are still many investors/traders who buy stocks based only on rumors without serious analysis, so the result was predictable: In the following season they were relegated, aka quit from investment activities because their losses are already too big. Actually, a qualified manager is not necessarily able to directly bring his team to be champions, like last night, Manchester United was once again got beaten by a mediocre team, Leicester City, although they've been handled by a world class manager who successfully brought the Netherlands ranks the third place in the 2014 World Cup: Louis van Gaal. Okay, Meneer van Gaal also may make certain mistakes which led to the lost of his team, but can you imagine what the results would be if van Gaal only took players without analysis if they will meet the needs of the team, and the like?

ENDD

Okay, the next question, when we should 're-shuffle' the composition of our portfolio? I mean, when we should sell particular stocks, hold the rest, and buy new ones?

There is no definitive answer to this question, because the answer may be different depending on who is asked. Some traders who are addicted to trade may shuffle his portfolio at any time during trading hours, where he could buy some shares in the morning, and sell it in the afternoon, and the next day he buy another stock (and sell it immediately). But unfortunately, based on the experience of many traders, including my own experience, too much buy and sell would produce nothing but losses and heavy cost of trading fees.

Meanwhile, if you want to imitate the strategy of portfolio rebalancing like the football managers, then you can take a look at your portfolio every six months. Actually, the ‘transfer window’ on stock market is open five days a week from Monday to Friday, at 09.00 AM – 04.00 PM, but you can implement your own transfer window, say every six months, ie at the end of the year and the end of June. Some investment experts in the past such John Maynard Keynes, suggesting to investors to visit their portfolio once a year only, beyond that you can 'drink champagne, go out and enjoy life'.

However, if we’re keep on vacation throughout the year, the vacation itself could be boring, so Keynes’ advice may not be a good idea. Here I will share what I've done so far. Remember that I’m a full time investor, so that beyond the activities of 'stirring' my private portfolio, write on this blog, read about investing, and organize seminars, I spend my time to travel or at home playing Playstation, aka doing vacation (only I don’t drink champagne). And here we go!

First, although I rarely trade my stocks, or watching the running trade, but I always check the shape of my portfolio at least once a month, ie at the beginning of the month (1 or 2) to look which stocks are up, down, and analyze the position of Jakarta Composite Index (JCI), is it already overvalued or not. I said at least, because on certain dates beyond 1 or 2, I could also buy or sell a particular stock, but it is not because I was staring at my computer monitor every day, but because of certain events. For example, in the last few days I heard many complaints from friends that the stock of United Tractors (UNTR) dropped, while there weren’t any issues. Because I did not hold this UNTR before, and there is still a bit of cash, I then take a look at UNTR until at some point I may decide to buy it. And the decision is not necessary have to wait until the end of the month.

For your information, Buffett was asked about when it's time to buy stocks? And he said, when you find an undervalued stock, and you have the money! It is a job of value investor to search for undervalue stocks, and when you find it you could immediately buy it, aka do not need to wait for the end of the month let alone the end of the year.

And second, beyond monthly works as explained above, I routinely analyzing the financial statements of listed companies every quarter, aka every three months. If one of my holdings do not perform as good as before, I may sell the stock. And if there is a company that has convincing financial performance, I may buy the stock.

So for myself, my ‘transfer window’ is open at the beginning of January to February, April, August, and November, aka four times a year. Beyond the factor of market correction that could happen at any time, I actively buy and sell the stocks at the times.

How to Keep Your Portfolio Undercontrol

You have to keep the number of stocks you hold. Take a look at football: It does not matter how often a club buy or sell players, but international regulation states that the maximum number of players in a team is 32 (outside the junior team), ie 11 players of main team, 11 reserves, and the rest of third players. So if Manchester United want to buy a new player, while the number of the team members is already 32 players, the manager of the club must release at least one existing player, whether it sells him to other club or break his contract (if he was not sold).

On the other hand, a club must have at least 16 players, not only eleven, if they want to join the competition, and of course it can be explained. Can you imagine if Real Madrid only have exactly 11 players without a reserve player at all? What if Cristiano Ronaldo or Gareth Bale are unable to play because of injury? Who will replace them?

So, in investing in stocks you must specify a maximum number of different stocks you can hold, and also the minimum. If you decide from the beginning that you can only hold a maximum of ten stocks, then when you are interested to buy the eleventh, you have to sell one of your holdings so that the number of your stocks will remain ten.

On the other hand, you also have to specify the minimum number of stocks you can hold, because it will be very risky if you put all your funds in one or two stocks only. As Barcelona cannot rely on Lionel Messi only, your portfolio also cannot depend on the movements of one or two stocks only. This is the main concept of diversifications.

After doing trial and error over the years, my maximum number of stocks is 15 stocks, and the minimum 5 stocks. In my opinion, this number reflects a healthy diversification strategy, which I never hold more than 15 stocks (the number may be raised someday, but it has not been necessary for now). I know some investors who often to buy new stocks but 'forgot' to sell the other, so their portfolio become full of uncontrolled holdings (read: most of them are in loss condition), and you certainly do not want to experience it, do you? So, hopefully with the strategy of 'minimum maximum', the composition of your portfolio will be much healthier than before.

Okay, that's all I can share for this week. If you have a related alternative strategy of rebalancing the portfolio, then you can also share it through the comment section below.