The Hardest Lesson

After more than 15 years and thousands of investment decisions I can comfortably say “they” are right.  The “they” I am referring to are the Market Wizards, those interviewed in the book with the same name by Jack Schwager. Reading the interviews of the best money managers in the world and that which makes them successful, without question, the two most important elements of successful investing are 1) managing your emotions/biases and 2) managing your positions.

In this week’s post I’d like to take a real life example of a position management decision that affects virtually all my clients at this point in time.  My TLT breakout buy call back in April of last year has handsomely rewarded those who jumped on board.  As you can see in the chart below it is up more than 25% since then.  In the first quarter of last year if I told you bonds would outperform stocks (not only would they outperform but beat by more than 2x) who would have believed me? Even I had my doubts and did not project this big of a run. But that is exactly what happened. I can remember the calls from clients who wanted to insure I hadn’t fully lost it as I added it into their accounts. “What are you doing?” they said. “Interest rates have only go one way to go … and that is up”. “When interest rates rise, the US Treasury long bond will get killed”. “Are you nuts?” Apparently I am but one thing I know is that not only did that bottoming pattern let me know we were likely headed much higher but I also know that when the crowd is on one side of the boat (interest rates can only go higher side) the market teaches the crowd a lesson.  It’s a painful lesson I learned long ago that being a contrarian can lead to outsized gains in many cases for those brave enough to try.

Now from a position management standpoint and the fact that we have come this far I would prefer not to give back the gains so taking profits has been on my mind. But so has letting the position run because a successful trend following methodology has two components 1) cutting your losers early and 2) letting your winners run.  Hmmm, appears we are at a crossroad. What to do, what to do?

Looking at a longer timeframe chart usually helps clear it up for me. In the 20-year look back period for the US long bond chart below, you can see its price has stayed nicely within the channel defined by the blue trend lines.  You should also notice we are approaching the upper trend line, where in the past, the bond has reversed course as it has acted as a ceiling. Ok, so that means it’s time to sell. You can also see in the upper RSI pane, price is more overbought than it has been in the history of this chart. While some may consider this a negative and giving more credence to the sell side, it can be viewed as a reflection of the strength of this recent move and hints it could go higher still since there is no divergence with price. Ok, so that means we should hold the position and let it run.

Well, that didn’t help.  What would one of the best baseball minds, Yogi Berra do?  In these situations he was very, very clear as he said “when you come to a fork in the road, you take it!” Ok, so much for help from Yogi, I still need an answer. Rather than ruin the message of “the hardest lesson” by telling you my plans, learning is best done by doing so I am going to toss this back over the transom and ask what you would do.

Are you a lock in profits and be happy with what you got kind of soul or would you rather let it run since making your investment account larger is something everyone wants individual?

Let me know your thoughts.