DISCLAIMER: This note is intended for US recipients only and, in particular, is not directed at, nor intended to be relied upon by any UK recipients. Any information or analysis in this note is not an offer to sell or the solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice and nor should it be relied upon to make investment decisions. Cestrian Capital Research, Inc., its employees, agents or affiliates, including the author of this note, or related persons, may have a position in any stocks, security, or financial instrument referenced in this note. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note's date of publication and are subject to change without notice. Companies referenced in this note or their employees or affiliates may be customers of Cestrian Capital Research, Inc. Cestrian Capital Research, Inc. values both its independence and transparency and does not believe that this presents a material potential conflict of interest or impacts the content of its research or publications.
Masterplan, Part Deux
As everybody knows, the key to making money with investments is to buy low and sell high. And you can find a metric-tonne of folks most everywhere on the internet who will tell you when is a good time to buy security X or Y. You can find no end of experts telling you to buy and hold forever. And you can find cope-posts aplenty when folks who bought and are holding watch those holdings decline in value.
Unless your liquidity horizon for all your investments is say a decade plus, unless every single one of your stock picks works out as you planned it, unless you’re happy to feed your brokerage account with new cash constantly, rather than harvesting funds from earlier investments to recycle into new picks - then, you ought to be thinking about, how do you know when to sell?
Institutions’ decisions to sell are often driven by fund structure. Funds may be closed-ended, so have to liquidate all investments at some point in order to distribute cash to investors; they may have limits on the % of a fund that can be in any one security, and so as a stock increases in value it may have to be sold; and so on. Family offices and individual investors however usually have more freedom and so the temptation to succumb to asset-manager marketing - which is to say, hold forever so that more assets can be managed forever - is stronger.
Buy and hold forever is a false God in our view. Sometimes a stock comes along which justifies an exceptionally long hold period. These are easier spotted in the rear view mirror than at the hard right edge of a stock chart of course. But if you happen to hold a stock whose underlying company is facing a huge addressable market of its own creation, where it is more or less a monopoly supplier, and where it is both growing revenue at a huge rate of knots and generating plentiful cashflow? You may have a long term keeper there. In staff personal accounts here at Cestrian for instance we think that Cloudflare ($NET) may be a lifer; we’re hesitant to go all-in at this stage because the company is yet to generate positive cashflow but we think it will get there in the end.
Most stocks though ebb and flow with the tide - their own local eddys and the wider market movements. Here’s how we think about when to harvest gains and get our cash back to redeploy another day.
Fibonacci Extensions
We are firmly of the view that stocks sell off on an emotional basis. In other words, when a stock has run up to a level that market participants deem too far, and/or has done so at a rate those same participants deem too fast - the stock can sell off. Now, we’re developing our x-axis toolkit and we’ll talk to you about it another day, so we shan’t deal with “too fast” at this time. But “too far”? That’s the domain of the Fibonacci extension.
If you’re not familiar with Fibonacci levels and their use in stock analysis, take a moment to read this note over at Investopedia. It’s very good and will give you the basics.
In our method at Cestrian we use Fibonacci extensions to determine, is a stock likely to keep moving up, or is it likely to sell off? And we set this in the context of Elliott Wave patterns. To spot a stock we think has run up too far, we’re looking for (1) a wave pattern we recognize and then (2) a big move up within that wave pattern that exceeds the typical Fibonacci extension level for that point in a wave cycle.
Like this: a Wave 3 up of a 5-wave series commonly ends around the 1.618 extension of the prior Wave 1. If it’s a big big move up? The 2.618 extension. Huge move? 3.618. With each level reached the stock is more likely to turn down into a Wave 4. And the depth of that Wave 4 down - measured by Fibonacci retracements - depends on the prior Wave 2. If Wave 2 was a big one - a 0.786 retracement let’s say - then Wave 4 is more likely to be shallow - a 0.382 retracement perhaps - and vice versa. Shallow W2, deep W4.
Let’s take a look at three current ETF candidates which may be presenting a time to sell.