System Thinking - Investment Operational Mechanisms for Success
Profit-Taking, Market Timing, Stop Loss, Buyback, Portfolio Management, Risk Control
Taking Profits
Taking profits is a normal reaction after earning, but the real question is what to do next.
Let’s look at Warren Buffett’s investment decision-making. Buffett once mentioned a scenario where a stock priced at $20 might rise to $40 but could also drop to $10. Most people would hesitate, but he would buy it immediately. One reason is the favorable risk-to-reward ratio, so he acts decisively.
What if the situation were reversed? What if a stock he planned to hold long-term suddenly surged in value? Would Buffett sell immediately?
In 2003, Buffett bought China Petroleum shares at 1.62 HKD and planned to hold them long-term. However, when the Hong Kong stock price jumped to 20 HKD after a domestic listing, he decided to sell all of his shares. A year later, he moved to BYD and held onto those shares for 14 years.
This shows that when stock prices significantly exceed his perceived intrinsic value and reach a level he considers overvalued, he decisively takes profits instead of sticking blindly to a long-term holding plan.
Investing and managing finances is an ongoing process. Taking profits is just the beginning of that thought process. From there, you have at least two options:
Hold cash and buy back after a drop—market timing.
Switch to other assets—stock picking.
Market Timing
Predicting declines in the financial markets is challenging due to a range of influencing factors.
According to data from A Random Walk Down Wall Street, with an annualized return of 15% and a 10% annual volatility—similar to the Nasdaq's risk and return profile over the past 20 years—the probability of profit after investing at Index Fund at any time is 93% over one year. This probability drops to 77% over three months, 67% over one month, and 54% over just one day.
Some might assume that after selling high, the chance of buying low later should be better. However, by randomly picking a historical high point and imagining a lower price point for future investing, even in a bull market with a 15% annualized return and 10% volatility, the probability stays below 50%. Over 20 years, the Nasdaq generally trends upwards with limited fluctuation, making timing declines tricky. This shows that even after selling high, there’s no certainty of buying low again, and as time goes on, market uncertainty rises, making decline probabilities hard to predict.
However, in the past 20 years, the Shanghai Composite Index fund's annualized return has not exceeded 5%, and its volatility has surpassed 20%.
Also, the annualized return of KLCI index funds over the past 20 years has been below 5.5%, with volatility exceeding 15%.
These market behaviors are very suitable for timing; many seasoned experts rely on timing once or twice a year to achieve excess returns.
However, if you are an ordinary investor without the best practice of investment, even in the case of those market shares, it’s not advisable to time the market easily.
As you can see, the annualized rate of return is too low, and its high volatility is too high which increases the likelihood of facing other issues that cause a big loss.
My personal experience is that I consistently achieve stable returns in the United States Stock Market. However, both the markets in China and Malaysia are quite challenging, often trapping me at low prices for extended periods before I can sell it successfully.
The US stock market tends to follow a pattern of a "slow, steady bull market" interrupted by sharp, quick downturns. For instance, in August 2024, a two-week decline caused the S&P 500's annual returns to drop from 19% to 7.3%, but a recovery was expected in the second half of the year. Such downturns can present buying opportunities when risks are somewhat lower and many investors can handle this level of adjustment.
Every few years, the market experiences significant drops—like a 36% decline during the COVID-19 pandemic in 2020, a 27% drop in 2022, a 50% drop after the internet bubble burst in 2000, and a 58% drop after the 2008 financial crisis. When the market shows signs of bouncing back after a sharp decline, it can be a good time to profit. Holding through downturns and selling when the market recovers can be profitable, but it’s important to prepare for potential adjustments before re-entering.
The stock markets in Malaysia and China behave differently, with declines often driven by unresolved issues rather than simple market corrections. These declines could potentially lead to further price drops. Buying solely based on those market downturns may not be advisable; it requires a deeper analysis of whether the underlying problems have been addressed.
What if it doesn’t drop after I sell?
If the market doesn’t decline after selling, there’s over a 50% chance that the sale was a wrong decision. Investors often miss out on re-entering when the market starts to rise again, losing potential gains. To avoid this, it’s important to set a buy-back time frame when selling. If the market doesn’t drop within that period but shows signs of a future rise, investors should overcome psychological barriers and buy back promptly. Investing is a game of probabilities, and no one can make correct decisions every time.
If you’re always right, you’re smarter than Warren Buffett. Many people lose potential gains because of subjective emotions or indecision.
A suggestion: when you sell, simultaneously set a buy order with a time condition. The system will automatically execute when the time expires.
Rotation Strategy
When investing, "rotation" is the strategy of selling one asset while buying another—a bit like picking the next fastest horse in a race. It’s also a strategy used to manage ETF investments effectively and leverages the momentum effect in equity markets, making it a trend-following strategy.
Selecting stocks involves three main questions:
Will switching from a rising stock to a stagnating stock result in gains?
Many investors tend to sell assets that have appreciated and buy those that haven’t yet risen or have smaller gains. However, high-priced stocks may continue to appreciate even after being sold, while underperformers might not recover or could decline further.
A proof:
Magnificent 7 stocks' refers to seven dominant tech companies—Apple, Microsoft, Amazon, Alphabet, Meta, Nvidia, and Tesla.
Market prices fluctuate as supply and demand adjust. A large price increase doesn’t guarantee a fall, and high valuations don’t always mean a decline—they change with underlying fundamentals.
For most investors, predicting whether a declining asset will turn around and increase in value is tough. On the other hand, it’s easier to understand why a rising asset is on an uptrend, though determining whether this trend can continue is more challenging but still more feasible than predicting a downturn.
It’s easier to understand why a rising asset is on an uptrend, though determining whether this trend can continue is more challenging but still more feasible than predicting a downturn. It is the most important logic implemented by many investors and speculators.
Are the evaluation standards between two assets the same?
Of course, it is not the same to evaluate stocks in different countries, in different industries, and other factors.
Can it outperform the US stock index over the short term?
This question is important when switching stocks. While all global stock indices are correlated with the US stock market and show cyclical strength, the US market remains a core holding. Other indices are usually supplementary allocations for excess returns. When considering switching, compare them first with the S&P 500 index to see if they can outperform the US market in the next phase.
BuyBack
When investors sense market downturn pressure, their instinct often pushes them to sell quickly to avoid risk. However, investing requires a long-term perspective and planning. If they sell hastily, they might have to buy back at a higher price later, affecting investment returns.
The question then arises: at what price should you buy back?
If the market drops by 5%, investors must carefully consider whether to continue selling. On one hand, panic selling could lead to market overreaction, and missing potential rebounds.
If the market does not drop as expected and instead continues to rise, investors may regret not waiting and selling early, missing out on higher returns.
If investors chase to buy high during a market uptrend and then the market begins to decline, they will face double losses.
The reason these questions are important is that historical experience shows that every market sell-off carries the risk of not being able to buy back at the bottom. Investors often end up buying at a higher price or reducing their positions, leading to lower final returns.
Consider market behaviors, uncertainty and volatility in any investment decisions
The United States market is not suitable for a timing-based investment style. Different markets have distinct market dynamics and characteristics, requiring investors to adjust their strategies accordingly.
From a long-term investment perspective, even if you guess the bottom correctly, it only reduces the purchase cost for that one transaction. Its impact on your overall investment is relatively limited.
The success of long-term investment depends less on transaction costs and more on asset allocation and risk management throughout the investment process.
What’s more important than timing is the investment portfolio. Building a globally diversified portfolio holds different assets from various countries in specific proportions.
Even without frequent trading, the basic returns remain stable due to global economic growth and inflation certainty.
By responding to market changes and the performance of different assets, they can better seize investment opportunities and enhance the overall return rate of the portfolio. For instance, in periods of rapid economic growth, increasing the proportion of stock assets; in times of economic instability or high market volatility, increasing the proportion of stable assets like bonds or cash.
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