Current bull market seems fitting to discuss “taking profit” – there are widely divided views on this topic.
Full disclosure – I am in the “taking profit” camp vs. the other (which says taking profit is a sin because it triggers a tax event – I also heard that nobody got rich taking profit (pun on Bernard Baruch’s famous investing advice – “nobody went broke taking profit”.
I am on the “taking profit” camp because I have seen how ephemeral profit can be – even in case in which you are doing all the right things. One episode I want to share took place in summer of 2020.
In hedge fund, you can see everyone’s P&L – on daily, monthly, or year-to-date (YTD) basis. The P&L dashboard gets refreshed every second – showing who is losing $$$ or is making $$$.
Therefore, it can get extremely stressful when the numbers are moving against you. This is particularly more so during the summer when stock prices just drift up or down throughout the day more significantly driven by flow rather than news. This is more common in s-mid biotech – where many stock prices go down down -5% with no news shortly after the open and then often recover throughout the day.
The scary part is that the P&L is not in %, but it is in dollars. For instance, if your team is managing $5bn and is losing -1%, your P&L dashboard will show that you are losing $50mm – it means the same, but certainly feels very different.
It has enormous impact on psychology – particularly for hedge fund managers who tend to be more motivated by money than normal people, but also have very poor job security.
Back to original point about how ephemeral profit can be… and why I BELIEVE IN TAKING PROFIT AFTER DECENT RUN
At my old team, we had a guy (we will call him GUY A) who are ABSOLUTELY CRUSHING IT in terms of $ /dollar P&L until May 2020. This was also without a supporting junior team member, so it was a heroic achievement. I think it was particularly amazing because other teams were getting fired left and right during covid19 (driven by herd behavior in hedge fund community that got EVERYONE in same trades, which I discussed here).
However, GUY A started losing money very fast in June and July – he lost all the profit he made (which were in tens of millions of dollars) and more – he was now in RED (down for the year).
Given that he was having a stellar year and he/management were extrapolating 5 month performance through year-end, he was already deep in the process of hiring a junior member to support him. The junior resource would have be paid from his bonus pool, which would have been based on his profit for the year. With no profit to show for it, the junior associate’s base and bonus compensation would now have to be subsidized by other people’s profit / bonus pools.
What was confusing to me was that he was on the right side of the trade while he was losing money – his analysis was spot on into quarterly prints, but stock prices moved the opposite way. In some case, he correctly predicted a massive beat on earnings, but stock was down -20% for other reason. For those companies that missed, it turned out to be a “clearing event” and stock got bought up – a bunch of Monday Morning Quarterbacks .
Current market dynamic is truly unprecedented – there is covid19 lingering around, all central banks are busy printing money, there is massive flow from retail, institutional investors are scared to take risk to provide liquidity, and cryptocurrency is becoming a new hot space that is attracting massive amount of capital – all of which are disrupting the traditional way to seeing, understanding, or predicting capital flow or direction of single stock securities or the overall financial market.
After the event, it is easy to be MMQ and come up with a bunch of reasons, but in reality, nobody knows or truly understands what is going on.
In this kind of market, it might make sense to take profit when you have adequate profit without a clear timeline on the catalyst – maybe post-earnings, you should take a look at your portfolio and trim stocks with weak thesis, but decent profit. They can go away pretty quickly. I think adequate profit to be 15-25% range – which is still extremely attractive in current rate environment.
For example, I exited QuantumScape ($QS) recently – I love the idea and their technology as it represents quantum jump (pun intended) in battery technology. However, I got lucky and made decent profit, so I got out because there is no near-term revenue and it still remains a deep technology bet without clear timeline on the next catalyst.
I will end today’s post with words of wisdom from Warren Buffet – the oracle of Omaha – “be fearful when others are greedy”
*not investment advice
