Sell Discipline

Fifty years ago this week, Dick Fosbury was the first to high-jump backwards in the Olympics. The story of his jumps and falls, is amazing. Originally, he failed to even clear the minimum height to compete, when he tried out in high school.

Throughout history, only different variations of straddling or jumping over the bar forward were ever attempted.

When Fosbury finally tried everything backwards, it worked. He cleared higher bars. He finally got to compete on that high school team. His local newspaper was in disbelief, and even poked fun at Fosbury’s technique calling it “like a fish flopping in a boat” and calling him “the world’s laziest high jumper.” But, he kept jumping and falling backwards.

Fosbury went on to win the NCAA Championship. He qualified for the Olympics in Mexico City in 1968 and won gold, while setting a new Olympic record.

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The Fosbury Flop became a famous story. Parallels have been drawn ever since about: technique over power, brains over muscle, countless trials and errors, and persistence through mocking doubts. Many businesses have tried to bend his story over their bars to inspire unconventional greatness.

As an investor, I think those all miss the key to the story even beginning. Maybe Fosbury hinted at it himself, when asked in an interview what kind of sacrifices he made to get there, he replied “nothing.”

He deserves all the credit in the world for trying to jump backwards. But that would have been impossible if the landing surface had not been changed at his school first. Previously, landing head first on the hard ground was not an option for anybody. Then a soft foam pit was installed. So, he was more able to try more things than anybody else.

The foam pit of the stock market is a sell discipline, in my humble opinion. Putting any sell discipline in place before you jump can completely change the trajectory of investment returns. If you are not worried about breaking your neck you will be surprised how high numbers can fly. The foam pit of a portfolio is a large portion completely removed from harm’s way to begin with.

When I wrote my first sell disciplines letter “How Do You Know When to Sell?” to my clients twenty years ago, it was from inside a Wall Street brokerage firm. I counted every single “Sell” rating on all stocks across all firm’s research departments. They totaled less than 1% of the recommendations. So, I suggested the answer would never be subjective research (called other things a few years later by class action attorneys). The only disciplined way to know when to sell is to answer the question before you buy.

For me, starting out, the rules would be simple.

1) 1% or less of a nest egg at risk in any one stock

2) Sell stop-limit levels set for every stock

3) Never add one red cent to a losing position

When I started my career and did not know much, I figured at the very least if I made it mathematically impossible for any one bad idea to open the barn door for big losses to the portfolio I would enhance my chances of survival.

"If a man didn’t make mistakes he’d own the world in a month. But if he didn’t profit from his mistakes he wouldn’t own a blessed thing.” -Edwin Lefevre

Little did I know that over the next twenty years that simple discipline would be the most valuable decision of all, still to this day. And, that discipline is the only ingredient to an otherwise constantly evolving stew of changes and choices that has never been altered.

I love more time to explore opportunities with a foam pit underneath. No meetings and no committees are needed to defend losing positions. I would much rather spend time on big jumps and deep dives into areas I want to learn more about, than do more work to confirm my own biases.

“However beautiful the strategy, you should occasionally look at the results.” -Winston Churchill

I have worked through two different 50% stock market crashes. Those three rules still fit perfectly on a small sticky note that remained on my screens throughout. Big losses hurt more than big gains help. Twenty years ago, the Nasdaq went up more than 80% then down 50%. When that happened over three years, a mutual fund could smooth that math out nicely and advertise +10% per year average annual return. The real math for a real investor is you now have less than you started with. Each $1 was turned into $1.8 and then cut in half to $0.90. One of the most misleading formulas on Wall Street is average annual returns. Yes, sell disciplines can work on funds and advisors also.

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“There’s nothing that cleanses your soul like getting the hell kicked out of you.” -Woody Hayes

As a huge bonus, I have learned sell-stops work well on any kind of debate. I use them on everything from questionable movies and restaurants, to relationships and blue jeans. Rather than buy a new pair of pants I need to stop eating.

“The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.” -William Arthur Wood

Good investing is a peculiar balance between the conviction to follow your ideas and the flexibility to recognize when you have made a mistake, early. Studies have shown the overwhelming reluctance in humans to admit when we are wrong (especially true of us men). The best investors I know are the humblest, not the most confident. Confidence, and his first cousin - arrogance, will forsake risk control. Learning how to lose is more important that learning how to win. A wonderful byproduct of this lesson will be the end of wasting time blaming any other factor. That is an incredible amount of stress-free time you are winning back, perhaps the most profitable trade in here.

“When somebody convinces me I’m wrong, I change my mind. What do you do?”-John Maynard Keynes

With all due respect to Mr. Keynes, I would not even wait that long. Convince yourself ahead of time what your definition of wrong is, because we smart humans tend to move our definition of “wrong,” right in the middle of the real problem.

There were a lot of problems leading up to the second of those two stock market crashes, ten years ago. I had a front row seat inside the belly of the beast, for the credit crisis, in the largest bank/brokerage firm at the time. Sell disciplines work on careers too. I knew something was wrong, but I was not smart enough to know exactly how it would all unfold. I did not need to figure it out. After a couple more red flags I decided to vote with my feet to do the right thing and leave. Our independent money management firm, free of any conflicts, was opened in 2006.

Your own set of sell disciplines can be ANYTHING, as long as they are set. There is no magic number to know when it is perfect to sell. Consider this chart and apply to any cockroaches in your lives. This is one month of the stock market during the unraveling of the credit crisis in September 2008. Each cockroach marked another “new low” with the headline that day. Turns out there are usually more.

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“By selling too soon.” -Bernard Baruch (When asked how he got to be so rich)

If you waited until seeing the last cockroach and sold at the absolute bottom at the end of September 2008 you could not have felt worse about it. Then, after the worst point decline in history, you avoided another 40% fall in stocks over the next 5 months.

Supreme intelligence is not a prerequisite for great money management, and it might even be a curse. Think about the very smartest people in any profession that you know. Most have been “right” most of their lives. Conditioned by everyone around them from an early age that they are the ones in the room who should come up with the answers. The smartest in each classroom at an early age, then in meeting rooms when they get older, are looked at by others to know the answer. Doctors, for example, are notoriously terrible investors. For good life saving reasons, it is because they better not be wrong! Great money management, on the other hand, is a peculiar profession unlike any other where admitting you are wrong so often, with such ease, is a prerequisite to great success.

(Excerpt from original Sell Disciplines letter) Consider the investment club for geniuses, at Mensa. During the greatest bull market in history, they averaged 2.5% annually vs. 15.3% from the S&P. During interviews with the club members they described indicator after indicator that have “helped” them. The leaders were said to have “kept readjusting their strategies every quarter or so.” Not one sell discipline was ever mentioned in the article. One member finally asked, “If we’re so smart, why aren’t we rich?”

Sometimes, not thinking is your smartest move. Too often smart people would rather try to figure out the markets, than make money in the markets. Human nature hardwires us with an ego wanting to BE right. More peaceful and profitable is wanting to get it right.

A misconception about disciplined rules across many aspects of life, is that they may be too limiting. You may find the exact opposite, they are liberating. Designing a new jump was Fosbury’s creative genius. Knowing he could he could fall backwards into the new foam pit was the key to unlocking that imagination.