We are now entering what is traditionally a time to sell to take
tax losses. I make no pretense of being a tax adviser and urge anyone
who has done a lot of trading to contact their personal tax advisor
before year end to get the best advice possible. Over the years, I have
listened to many investors of the "buy and hold" ilk who refuse to sell
positions no matter what. Many undoubtedly fell into that "hold no
matter what" trap when the market crashed beginning in the year 2000.
I have urged traders to formulate a personal business plan until I
am blue in the face. Most never bother to create a plan for
themselves. In an earlier article, I set out several criteria that are
helpful in the creation of such plan. It is my personal belief that
successful trading requires that exits be planned before entries are
ever made. For example, if a trader decides that he will enter on a
bounce off a trend line, he also may decide that his exit will be a
break down through that same trend line. In my estimation that is a
reasonable exit strategy. Of course, there are innumerable potential
strategies such as MACD crossovers, stochastics crossovers, moving
average crossovers, candlestick exits, and so on. It is not nearly as
important what exit strategy is used as that some exit strategy is
chosen. I have never understood what exit strategy is implied in "buy
and hold." Is the exit when one needs the money or is it death? I
personally don't believe either of those choices is particularly
desirable. Death, of course yields a wonderful windfall to heirs.
Exiting when one needs the money can be good or bad. If the position is
profitable at the time, then things have worked out. However, if the
position is a losing one, the investors should probably have exited some
time before the need for cash arose.
What absolutely amazes me is those investors who have told me that
they were unwilling to exit a position even knowing they had achieved a
wonderful profit because they would have to pay taxes on the profit.
Instead, all too many have told me that they watched their profits
evaporate and turn into losses. I can't tell you how many people
fell into that category when the market crashed beginning in the year
2000. Many lost as much as 40% of their portfolios. Think about that,
they gave up their unrealized gains and just held on while they lost 40%
of their portfolio value rather than pay a relatively small capital
gains tax on their gains! That just doesn't make sense to me. As
positions become profitable, the investor should, in my view, have an
exit strategy to capture at least some of that profit when the stock
turns down.
If we look at those investors who bought shares of QQQQ in the
middle of 1999 and had no exit strategy other than buy and hold, they
would still be holding on today and would be down more than 60 points
from the high in 2000. In the middle of 1999,the Q's were trading in
the mid-50s. They went to almost 120 in early 2000. As I write this
article, they have not yet returned to 50. Is it an intelligent
argument to say: "I am a buy-and-hold investor and I did not want to pay
a 15% capital gain tax on my gains so I am holding on to an unrealized
loss of more than 50%?" Maybe it's me, but I don't understand that kind
of thinking.
If we have a game plan and that plan includes an exit strategy, we
won't fall into the trap discussed in the preceding paragraph. As the
new year approaches, let me suggest that you review my earlier article
on business plans (Business Plans for Traders and Investors) and either construct your own plan now or review your
existing plan to make it current. In either event, it will help put you
ahead of the crowd.
Good Trading!
Bill Kraft
Mr. Kraft's past articles are posted on our website for your review.
-- by the Dividend Investor Team
