Cramer talked about ABB and selling ABB into a rally because you can pick up ABB cheaper. In fact you hear it everywhere. Sell into the rally.
Is it right to sell into a bear rally? I decided to pursue this using numbers and came to conclusion that selling into a bear rally is wrong. This is based on the assumption that you are out of the market wanting to get in, and not in the market wanting to get out.
Assuming we have perfect timing then the following buy and sell scenario could be defined.
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We buy at zero, sell at X, buy at Y, and then in some time in the future sell again at X. The total profit for this situation is (X) + (X +Y). Not lets take the situation where we don’t sell at X, but still buy at Y. The total profit is still (X) + (X +Y), with the difference being that in scenario 2 you have double the share count.
In Excel terms the calculations are as follows.
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The gains are completely identical, with the difference being the footprint in total share count. You could argue that using the second approach you setup a larger risk.
The problem with selling into a bear rally is that you don’t actually know if prices will go down. Cramer says they will, but can you be sure? Consider the following scenario.
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In this scenario the total gain is X for both buy sell situations. Though there is a big difference in that the selling occurs at different points in time. And here is where I want to make my point.
The second X value depends entirely on when you bought. There are two situations when buying; a bull market or bear market. If you buy in a bear market then you buy a stock at depressed values. If you buy in a bull market then you buy a stock at inflated values. Thus the end values in the medium term of a particular stock will resemble the following graphs.
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My assertion is that the probability of a stock ending higher in a bear market is higher than a stock ending higher in a bull market. And likewise the probability of a stock ending lower in a bull market is higher than a bear market. Thus buying and selling in a bear market is pointless since you don’t know if the stock will drop to previous levels.
The key is to buy in bear markets and sell in bull markets. It is very simple theory yet we don’t do it because of greed and fear. In a bull market we are making money and want to make as much money as possible. And in a bear we are afraid of loosing since buying implies buying into the abyss. In either situation you are playing against emotions and is hard to do for most people.