Good News and Bad News About Bubbles
Let’s suppose you were smart enough to buy Bitcoin below $10,000. Or Tesla, below $100. Or any other shiny treasure, an investment which is skyrocketing since then. We see plenty of this sort of stocks or cryptocurrencies in this huge bull-run. (Also called bubble, or extreme price environment.)
And now, the fears and doubts don’t let you sleep. What should you do? To sell, or not to sell? Maybe even add more to your portfolio? I have good news and bad news. The bad news is that you never know when a bubble will burst. And the good news is that you can earn and stay invested at the same time. Let me explain it.
Unfortunately, you can’t forecast the exact top of a bull market or bubble. Not even Nobel-price laureates can. Timing–buying at the bottom and selling at the top–is challenging; forecasts are mostly inaccurate. Many authors call it an impossible mission. Your selling (and buying) decisions will always be risky. If you sell now, and prices keep ballooning, you lose money and will feel sad. If you don’t sell and the market crashes, you lose too.
Sell in a Bubble in Parts
But the good news is, this unpredictable environment also means an opportunity. You can sell a portion of your investment that already covers the purchase price. After that, nothing terrible can happen to you. The question is only the extent of your gains. (Assuming you did not use leverage because it is hazardous even in a winning streak.)
You can sell in a bubble or strong bull run in parts, always only a certain amount or a certain proportion of your winner asset. You can cash out one-third, one-quarter, or one-tenth of it. For example, you might decide to sell ten percent of your Bitcoins at $60,000, the other ten percent at $70,000, then at $80,000, etc. Or liquidate some Tesla stocks at $600, $700, $800. If you always sell ten percent of the actual amount (not ten percent of the initial one), you will never run out of stock.
Psychological Benefits of Selling a Part
So, no matter how high the price goes, you will always have a certain amount left in your portfolio. You will always be able to tell your friends that you sold Tesla near the top. And it will be accurate. (If you are very confident in your investment in the long run, you can buy back a part of it if the value falls to the previous level.)
And from a psychological point of view, if prices go up, you can be happy that you still have a portion of your investment. And if they crash, you feel good because part of your capital is already in cash. (Of course, this can’t help those who always see only the negative side of everything.) As we know, psychology matters much in investing.
This technique reduces the risk of your investment but also the maximum profit that you can achieve. Your return will be lower by rising prices than if you stayed 100 percent invested. But think about what happens in a collapse. You will be pleased that part of your wealth is cashed out. This risk reduction is at the heart of the technique.
A Sell-Side Version of Dollar-Cost Averaging
This technique is similar to dollar-cost averaging (DCA) but on the sell-side. By DCA, investors divide their capital into smaller amounts and are spending it for periodic buying. (To reduce the adverse effects of volatility.) But by the DCA, “the purchases occur regardless of the asset’s price and at regular intervals.” The technique aims to avoid making one massive investment that is poorly timed, at a wrong price level. (More on Investopedia here, or here.)
DCA is a method to diversify buying over time. We can apply something similar to diversify our selling across time, too. The goal is to reduce the risk that one more significant sale happens at just the wrong time–wrote people in this Reddit forum.
How Should We Call It?
How much should I sell? There is no rule. If you are scared, sell more. If you see a strong uptrend and are more confident, sell less. However, if you want to eliminate personal biases and feelings, stick to your pre-designed rules.
First, I couldn’t find a name for this exit strategy, although many people are using it. (I wanted to call it “selling price averaging,” or SPA.) Later I discovered the terms “reverse dollar-cost averaging” (Wikipedia) and “taking partial profits” or “partial profit taking” (Myforex Global). My method is similar to the second one.
Conclusion–Lamborghini, Tesla, or Bankruptcy?
Risk-reducing and psychological benefits, more liquidity are the three main goals of this method. (Other alternatives are timing and the use of stop losses. But all have their advantages and disadvantages.)
Of course, this way, you will never make as much profit as if you had been fully invested all the time. But at least you may avoid a part of a hefty fall, too. You’ll be able to tell your grandchildren that you won in the big bubble market in 2020-2021 (or 2020-2025, who knows). Perhaps, you won’t have a Lamborghini but drive a nice Tesla. And you can avoid bankruptcy, won’t lose your house.