A weekly newsletter based on the fact that stock market sectors are made up of industries, that industries are made up of individual stocks, and that individual stocks in the same industries and sectors move as a group. The proven best way to profit from the stock market is to keep your funds invested in the stocks of top performing sectors/industries at all times, and the best measurement of performance of these sectors/industries is their price movement over the previous six months. Below you will find commentary of Sectors, Industries, and Stocks based on the most recent 6-month period as well as updates on the past week’s action...

October 6, 2006

Why We Sell, How We Sell 

Justin Mamis's When to Sell (1977) and Donald L. Cassidy's It's When you Sell that Counts (1997) are two of a handful of books, treatises, lectures, or studies devoted to the selling of stocks after you've bought them. In a world where probably 98% of all investment advice is about "buying," the concept of "selling" is as remote as a Siberian village.

Anyone can buy. It's easy. Pick up a phone. Click a mouse. Answer "Yes" to the salesperson's question. You know through experience that there's an army of helpers out there to guide your decisions about what to buy and how to execute your buy orders. We are a buying society where shopping is a national pastime. And shopping for financial instruments is no different.

But when it comes to investor complaints, they're usually centered around, "I got out too soon," and "I stayed too long." Both reflect a failure in selling. Both express an emotional cry of regret.

So, let us begin by stressing that selling is much more important than buying, which brings up a good question: "Why is selling so hard compared to buying?" We are reminded of the prayer, "Oh Lord, just get me out of this one and I swear I'll never get in trouble again," so it must be part of human nature to get into things easily. Getting out is always the harder part.

All quests begin with an optimistic assessment of the outcome. If it weren't so, we would never take that first step. However, once into our predicament of being an "owner" or a "possessor," we are then faced with the problem of what to do next.

The stock market has a few old saws on "how to sell" - but none of them make much sense. They can be so arbitrary that no normal human being could be expected to consistently follow the rules: sell if the stock drops 7%, or sell if the stock breaks downward through a trendline, or sell if the stock retraces 50% of its rally, or sell if the stock doubles.

Also, the guidelines can be so vague that they would be subject to such a multitude of interpretations that you'd never make a decision: buy on rumor; sell on news (this news? or that news?), or sell if the earnings are disappointing (how disappointing?), or sell if the management team turns out badly (how would you know?). 

Then, add to all this mumble jumble the psychological factors like "separation anxiety" - getting rid of something you've become attached to. Try cleaning out your garage sometime and experience all the reasons you can come up with for keeping something that really should be let go. They don't talk about getting "attached" to your stock for nothing. It can be real.

Finally, when it comes to making that ultimate decision to sell, we frequently desire to have somebody else make it for us so if it's wrong we won't have ourselves to blame. Thus, the popularity of "managed" accounts or mutual funds. It relieves us of the responsibility of making a decision.

Well, the Simplespread Institute has a way to cut through all the above clutter and make selling a part of the normal course of daily routine. That's why we talk about Taking Money Out of Wall Street. It embodies ACTION. We don't believe you've succeeded at anything until you're out of the market, and that means out (as in sold) of your investment. Paper (profits or losses) are just that - paper. And if you don't first take it out of the market, then you can't put it back in so as to take advantage of another opportunity, which is what the game is all about. 

Compounding.

When you add call selling to your investment strategy, you've just added the most potent tool you will ever have at your disposal to use toward becoming a successful investor. Let's take a stock that is trading at $43 while the $45 call (the right to buy the stock at $45) is trading at $3. If you buy the stock at $43 and sell the calls for $3, you've paid a net $40 for your investment position. At anytime during the duration of that contract, you can be called upon to deliver stock at $45. No more questions asked. You don't care if the stock reports fantastic earnings, goes to $100, or finds the cure for cancer.

Your goal was to make a profit of 12.5% over the course of the contract. Period. The only concerns you would have as you hold the position would be how fast the call owners take the stock off your hands if it rallies above $45. 

Your goal is established prior to making the investment (buying the stock and simultaneously selling the calls). The only thing yet to be determined is how you will eventually get out of the position once it's established. If the stock goes up above the exercise price of the call ($45), your decision will be made for you - by the call owners. If the stock lingers near where you bought it, you will profit from the time decay of the calls wasting away. And if the stock drops, you will reduce your potential loss by the amount you received from selling the calls, perhaps to no loss at all.

We won't say that the selling is automatic, but it's about as close to that as you are ever going to get in the stock market. An option writing program takes most of the emotion out of decision making. 

However it works out, the calls are the decision makers based on what the stock does. The calls move you to action. The stock and the calls are intertwined - joined at the hip, so to speak. Eventually, the calls yell at you to "do something." And you will. 

You have to.

Selling a position will never be a slam-dunk. But by selling calls on stocks you buy, it becomes considerably easier. No longer will you be haunted by the  "I got out too soon" and "I stayed too long" demons. You set your goals and will be happy if you succeed. It's all you can do - and it's more than most investors will ever try.

FOR THE WEEK...High Enough?

Can you take me high enough
To fly me over (fly me over) yesterday
Can you take me high enough
It's never over
Yesterday's just a memory...

                                                                    - Damn Yankees

We don't know if we're anywhere near high enough yet, but the Dow Jones Industrial Average finally eclipsed its January 2000 top this week. But we've still got Glassman and Hassett's Dow 36,000, Elias's Dow 40,000, and Kadlec's Dow 100,000 ahead of us. Or maybe it'll be Prechter's Conquer the Crash, or Arnold's The Great Bust Ahead, or Bonner and Wiggin's Financial Reckoning Day. There's never a dull moment in stock land.

Tobacco continued its stint at the top of the pile. Utilities remained stuck in the #2 spot. Real Estate moved up to the #3 position with a very good week. Aerospace/Defense, the top performer of the year (+21%), had its best week of the year, and moved up to #4. The #5 spot was claimed by Media, also one of the strongest performers this year.

Defensive sector Food & Beverage stayed in the Top Ten at #6. In the absence of any damaging hurricanes this year, Insurance claimed the #7 spot. Drugs held firm at #8. The Dow Jones Industrial Average came in at #9, still demonstrating that the Generals are doing all the work this year. Rounding out the Top Ten was Consumer Non-Durables. The last time they made it into leadership was summer 2004.

With all the hoopla over the Dow's new all-time high, one could be forgiven for forgetting that it's been a rather narrow rally. Not only have the Transports failed to confirm, but many of the overseas markets (especially emerging) have come nowhere close to their recent May highs. We have to be careful here as buying is concentrated only in the strongest of the strong companies, and  is not what healthy rallies are made of. For things to continue on up, we need to see a broadening of participation. Otherwise, it could very well give way to failure.

With the Dow at all-time highs, Simplespreaders should have cleared out all positions by now and be on the lookout for new opportunities during the next selloff. Until then, we sit.

THE BEST...