Analysis of My Stock Trading History

I spend my time teaching and mentoring individuals and groups on how to make better investment decisions, specifically with stocks. I've been investing in stocks for over 15 years now and I know I have incorporated a certain discipline and process in making investment decisions and I've thought I have done a good job considering what's been in going on in the world. I know my portfolios are generally going in the right direction, but I have always thought about how effective I have been in the buying and selling over the years? Fortunately, I kept pretty good records of my past trades, so I thought I'd go through my spreadsheets and see how well I ha­ve done and maybe I can learn something about how I've invested and if I've grown along in the process.

I decided to review all my sell trades going back to 1999, which covers the last 13 years (2001 is not included because I was busy starting up my investment research consulting business). I think it's a good range of time to explore because it covers some of the highs and lows of the stock market and economy as a whole (i.e. Dot Com bubble, Real Estate/Credit Bubble, Euro Crisis, Commodity Boom, Emerging Market Boom etc). I am looking at the sell transactions because it is the sell decision that will trigger a tangible, realized profit or loss and it assumes that I made a decision to buy and build a position on this particular stock based on whatever analysis I undertook over a period of time.

I grouped each sell transaction according to a range of returns I gained or lost and grouped them by year. The distribution of my sell transactions form 1999-2012 (as of August 30) is below

 

 

 

Year Number of Stocks Sold < -20% < -10% Neg 5% to 9.99% Neg 0.1% to 4.9% 0.1-4.9% 5.0-9.99% 10.0-19.9% 20-29% 30%+
2012* 15 5 1 0 0 2 0 4 3 0
2011 17 0 0 1 2 1 2 5 4 2
2010 18 2 2 2 7 3 1 4 2 1
2009 22 1 2 0 3 1 2 1 3 9
2008 22 2 5 1 1 3 1 1 6 2
2007 11 1 0 0 0 2 2 1 4 1
2006 13 0 1 0 0 1 0 5 6 0
2005 17 0 0 1 5 0 2 5 1 3
2004 14 2 0 2 0 3 1 3 1 2
2003 10 2 0 0 0 0 2 0 1 5
2002 7 0 2 1 0 1 0 1 2 0
2001 0 0 0 0 0 0 0 0 0 0
2000 6 0 0 0 0 0 0 1 0 5
1999 3 1 0 0 0 0 0 0 0 2
Totals 175 16 13 8 18 17 13 31 33 32
Pct   9.14% 7.43% 4.57% 10.29% 9.71% 7.43% 17.71% 18.86% 18.29%


* Year To Date August 31, 2012

Observations

First a few stats:

% of stocks sold for a gain: 72%
% of stocks sold for a loss: 28%

% of stocks sold overall for a double-digit gain: 54.86%
% of stocks that were sold for a gain that were double-digit gains: 76.19%

% of stocks sold overall for a double-digit loss: 16.57%
% of stocks that were sold for a loss that were double-digit losses: 52.73%

Ratio of double-digit gains vs double-digit losses: 3.31:1

The first item I noticed was the number of sell trades I made. Over 13 years, I made 175 trades (on average about 14 trades per year), which is not much and reflects that I really try to keep my trades to a minimum to save on commissions. In addition, I ve managed up to 5 portfolios so it is really not a lot of trades. The chart doesn'­t reflect the number of buy trades which I know is much higher because I'­ve always built up my positions slowly and over time instead of making one giant bet. When I sell stocks I tend to sell the whole position when it reaches a certain return I'­m trying to obtain. When I was younger I also didn'­t have as much money to work with so I made more trades. Now I'­m putting more money into each trade to save on commissions, which can eat up your portfolio over the long-term.

The big number that jumps out is the percentage of trades where I lost money which was at 30%. I really didn'­t think it was that low. Of the 30% of loss trades they were either small losses or large losses (> 10%). The lesson for me here is that losses will occur. You can set your watch to it. As an investor you have to expect to incur losses. Not every stock you buy will pan out, even if you analyzed it from every direction. As Peter Lynch wisely commented, for every 5 stocks 1-2 will be winners, 1-2 will do average/break-even and 1-2 will be dogs. The key for us as investors is to keep the losses to a minimum and manageable level and consistently achieve positive returns within a range that you are comfortable with. For me this is evident when I look at the ratio of trades of double-digit gains to double-digit losses which is 3:1.

As humans, we hate loss of any kind for obvious reasons and we have a hard time dealing with it. When we lose money in a stock, we are likely to become more gun-shy about making the next investment decision. We'll err on the side of caution, which can limit future opportunities to make successful decisions. The classic examples are the events of the last 4 years. So many investors lost money in the financial crash (including me but I was also buying heavily during that time) that they either took their marbles home or put it in something safer like bonds. Then add the events in Europe recently and essentially investors are frozen and gun-shy. They don'­t know what to do and what has happened since this ice age? Since the crash in 2008 the market has made up all the losses and then some, but a lot of investors were not there to capitalize.

The best way to approach losses is to have a mindset of a cornerback in football. When they give up a touchdown or take a pass-interference penalty, they are coached to forget about it immediately and to have a short memory. The play is over so they are trained to move on and not dwell on it because it will create doubt and impact their ability to be effective going forward. I think that is the same attitude we have to take in investing. When I sell a stock at a loss, I try to put it out of my mind. Acknowledge it happened, take some lessons from it that you can learn for the future, but turn the page right away and reconnect with your investment strategy and discipline. For people this is an extremely difficult concept to grasp, which is why having someone like an investment coach is valuable to instil and grow this discipline. It'­s all psychological (have you noticed, I haven't mentioned anything about numbers, and business models, and economic indicators?). Making successful investment decisions is just as much about understanding behaviours and sentiments than it is about financial statements.

When I look at the distribution of the profitable trades, it skews heavily in the double-digit range. Almost 3 out every 4 profitable sales were for double-digit returns. This is consistent with my approach which is to buy stocks that are trading at a discount and that I feel have significant potential to appreciate. I also have over the years established an exit point or a minimum return that I am comfortable achieving. For me it has been in the 20% range. In other words, any stock I buy, I'm hoping to generate a minimum 20% return. When I come close to the 20% level, I re-evaluate if it is time to book the profit or hold on if I feel the story is still good. The 20% return threshold is a level I'­m comfortable with because it is a healthy return that is greater than inflation and is consistent with my risk tolerance level. I have on many times sold a stock at a 20% gain only to see the stock go up another 40-60%. It happens and it sucks to leave money on the table, but I'­ve trained myself to with an attitude that if I can find enough 20%+ winning stocks, then over the long-term I can achieve higher returns at a risk level Iím comfortable with.

It also works the other way. Over the past few years, I've been implementing a 20% loss rule where if a stock goes down 20%, I sell and take the loss. This way I'm controlling my loss in a disciplined manner. The key point I follow is if a stock goes down 20%, then you need the stock go up 25% to get back to break-even. If it drops by 50% then the stock has to go up 100% to break even, which is extremely difficult to do. So it's more efficient to take a gulp and bite the bullet and take the loss on your terms and play for another day. The best example of this that can illustrate is another football case involving one of the best running backs ever, Barry Sanders. Sanders was known for his highlight long runs and nifty moves. One thing that never got mentioned was that in plays where he knew he was going to lose yards, he took the loss right away and dropped down or quickly ran out of bounds. He figured there was no point expending useless energy and risking injury. He would take that saved energy and harness it for another big play. Great running backs have this key instinct and it makes them more durable and successful in the long-run. Investing is no different.

The results overall give me some comfort that the approach, attitude, and discipline I've developed over time has some merit to me personally as an investor. I do think there are nuggets of value and knowledge that everyone can take from this, but I would not endorse this as the be-all method to successful investing. Mr. Market has a consistent ability to make you look very bad and as an investor you have to be mindful and be open to adjusting to what the market will be offering you. I know that I'­m a very different investor today than I was 14 years ago and I know I will continue to refine and tweak my approach and that I will make mistakes along the way, but I'm confident that if I stay true to the principles below, I will make more positive investment decisions than negative ones.


Lessons I'­ve Learned:

1) Have a core strategy and stick with it
While I'­ve tweaked things here and there over the years, the core principles have remained constant, which is buy great, well-run companies, with strong balance sheets that have demonstrated an ability to manage capital effectively and consistently over a long-period. These companies should be generating consistent Economic Profit (i.e generated returns on capital that are greater than the cost of capital). When you find these great companies, buy their stock if they are on sale and yield potential for generating 20% returns or greater.

2) Keep costs low
Keep the number of trades low to minimize commissions. Instead of building a position in a stock via purchasing monthly, make larger purchases less frequently. Also look for vendors with lower trading costs. This year I switched to the Scotia iTrade system and have lowered my trading costs by 2/3. That'­s a big chunk of change that is in my pocket that I can invest.

3) Have an exit strategy
Before you even think about buying a stock, you should have established what the minimum return you are expecting from it. You should have an idea what is its intrinsic value and then determine a return you are comfortable obtaining based on your risk tolerance. (For me it'­s 20%. For you it could 15% or 40%). At the same time you should also have established the maximum loss you are willing to take and be disciplined enough to sell at that loss no matter the situation. If the company rebounds, you will still have a chance to come back. My max loss is 20% so basically for every company I invest in, I have a 40% range to play in, which I'­m comfortable with.

4) Have a short memory
You will lose money in stocks. Your goal is to minimize and control the loss. When you reluctantly have to sell that stock that all your analysis said would double in value and was a can'­t-miss for a loss, do it fast and turn the page.

5)Understand the Market Psychology and Exploit It
When I started investing, I was very focussed on the quants, the numbers side of things. I developed my own financial model driven on the Economic Value Added or Economic Profit model, built my own database and picked stocks based on it. I stayed true to the model and it did serve me well. Over time though I noticed that while financial fundamentals are key to identifying great investment opportunities, it'­s also important to understand how the key players in the market behave because their behaviour and attitude can determine when you enter or exit the market and take positions in the companies you'­ve identified in your fundamental analysis. I learned that understanding these sentiment or contrarian type indicators can be extremely helpful. I'­ve learned it's also important to develop an internal discipline. A discipline to stay true to your strategy, especially when there during major market downturns and a discipline to keep your emotional intelligence in check during those times of positive and negative euphoria. It means coming to grips with a concept of buying companies when there is fear in the market and sell them when there is giddiness and apathy sentiment in the market. As humans we are just not wired to buy losers. We want to emotionally be with the winning team. It means going against the crowd and looking for Consensus and taking the other side of the trade. All these elements are just as critical for success as an individual investor. In a way this sounds like market timing and I know it'­s impossible to pick exact tops and bottoms of the market, however, anytime you are executing a trade there is an element of time being attached to it so you are hoping that the trade is being made relatively close to an ideal time to realize a profit and often market sentiment can represent a milestone in time to act effectively.

I really believe that anyone can learn and develop these traits and become a successful investor with practice and mentoring. As Peter Lynch said, "Everyone has the brainpower to follow the stock market. If you made it through fifth-grade math, you can do it." I look at my results, and I know I didn'­t achieve them because I knew something more than someone else. All my decisions were based on information and observation that was publicly available. There was no magic potient. It was hard work, discipline, a heightened awareness of what's going on around me and the world and a willingness to challenge conventional wisdom and these elements will continue to be important to hold on to as I move forward.