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Selling a Sell Discipline

Investors will now listen to reps when they suggest orderly exits from investments. Risk management and sell disciplines are popular again. The legacy of the recent bear market will be greater attention to exit strategies, sell disciplines and technical indicatorsas well as more realistic expectations. We always knew it was important to manage clients expectations, says Paul Schatz, a producer and

Investors will now listen to reps when they suggest orderly exits from investments. Risk management and sell disciplines are popular again.

The legacy of the recent bear market will be greater attention to exit strategies, sell disciplines and technical indicators—as well as more realistic expectations.

“We always knew it was important to manage clients’ expectations,” says Paul Schatz, a producer and chief investment officer at Beneficial Capital in Woodbridge, Conn. “But if you told them, ‘We’ll make you 10% or 15%,’ they laughed at you.”

“Risk management was not something people would look at ... with the Nasdaq returning 85%,” agrees Maia McGehee, whose firm, Hermes Econometrics of San Rafael, Calif., allocates fund portfolios for brokers’ clients.

The firm is busy taking calls from reps “looking for some kind of analysis somewhere,” McGehee says. “We get these accounts in, and I wish they had sent them to me six months ago.”

But back then, investors may not have been so concerned with risk-reduction strategies. And they’ve “always been told to invest for the long term,” adds Jeff Hill, a broker with A.G. Edwards in Boynton Beach, Fla. Patience is good, “but it can work against you, too. It’s very difficult for them to change that [buy and hold] philosophy.”

Finding (and Selling) a Discipline

To keep from being surprised again, reps are looking more closely at technical indicators.

“Bear markets are a technician’s best friend,” says Peter Martin, the technical analyst at Prudential Securities who runs the firm’s point-and-figure charting program. Point-and-figure is a form of technical analysis that measures price trends for a stock on a daily basis.

“When the market is going south, technicians do most of their business,” Martin says. “In a raging bull market, you can just throw darts at the wall.”

The problem with fundamental analysis in a down market is that “the fundamental guy has to sit there until the actual numbers come in,” says Tommy Dorsey of Dorsey Wright & Associates in Richmond, Va., which runs point-and-figure charting programs for brokers ( The fundamental analyst “can’t change his opinion until the numbers change, and by then the people who do understand the company have begun to exit,” Dorsey says.

One rep who follows charts admits that it’s not easy to spot signs of market weakness. The broker, whose firm would not allow him to be quoted by name, uses both point-and-figure and daily price-and-volume charts. He says he spotted early warning signs that both Cisco and Sun Microsystems were starting to deteriorate as far back as August (see “Technicians’ Tips,” Page 63).

But then he faced the harder task of selling the idea of selling. By September, the rep’s clients had received his sell recommendations. Many took no action because Cisco was a “sacred cow,” he says. Some had owned Cisco for as long as six years and hadn’t sold a single share. Now, he was telling them to sell all of it.

“I called people until I was blue in the face,” he says. At that point, the stock had dropped to the 60 to 70 level, off a high around 80. But the sell-off still wasn’t that dramatic. Given the history of the past few years, during which many tech stocks dipped only to go higher on the next bounce, many of his clients were skeptical.

Of course, the ones who took his advice now think he’s a hero.

Allocating Away Risk

Victor Livingston, a rep with Salomon Smith Barney in Boston, works with asset allocation models. He emphasizes the importance of looking not only at a particular sector like technology, but also at subsectors—semiconductors versus hardware versus software—as well as individual stocks. He wants to make sure that no one sector or stock is overweighted in a portfolio.

This attention to weighting itself creates a disciplined approach to taking profits during a bull market, Livingston says. “There’s a delicate balance between rebalancing too frequently and not allowing the sectors that have performed well to run,” he adds. “That’s one of the biggest challenges in a volatile market.”

Livingston’s allocation work is now pointing to some opportunities in technology—if an investor has a long enough time horizon, he says. He is beginning to average into tech stocks while remaining diversified in other segments such as health care, financials and energy. The “silver lining” in this market is the chance to upgrade portfolios by selling second-tier tech names and substituting top-tier stocks like Cisco, Intel and Microsoft.

Likewise, areas that have shown recent strength are now overweighted. For example, one of Schatz’s clients holds Philip Morris stock, which was originally 10% of an account, but now represents 50%. Schatz advised the client to take half of his Philip Morris gains.

That message of caution may be heard. Liz Weiner-Schulman, a broker with Merrill Lynch in Tucson, Ariz., and a past president of the Investment Management Consultants Association, notes that investors new to the market in the past few years are experiencing their first serious downturn. Not only that, but the pain is “much more in your face” because of the tremendous amount of coverage on TV and the Internet, she says.

“I think we have to educate clients that what happened in the past five or six years, with double-digit returns, just isn’t the norm,” Weiner-Schulman says.

Exit Strategies

“This market has taught a lot of people lessons,” says Jeff Hill, a broker with A.G. Edwards in Boynton Beach, Fla.

The main lesson: Use stop losses. They might be set at 10% behind the stock's current price, Hill says, and move them up if the stock continues to rise so you “continually have that protection. Most people in the past have let it ride.”

Don't forget, though, that stops can trigger a lot of short-term taxable selling. But considering what a lot of portfolios look like these days, a lot of people “would rather have paid taxes,” Hill says.

“I got stopped out of a whole bunch of Intel and Microsoft last year, and my clients were pretty upset,” says Nikki Chicotel, a broker at Wells Fargo Van Kasper in San Francisco. But when it comes to “‘buy and hold forever,’ I don't think there's such an animal anymore,” she says. “For everything I buy, I already have an exit strategy in place. Everything has a stop [loss] on it.”

If she gets a jump of 20% to 30% in a stock, she'll take a third off the table. Don't worry about short or long term, she says. “It's a gift — take it.”

If the stock doubles, she'll sell another third. The balance that remains is the portion “I'm hoping to keep as a core position forever and ever for the buy-and-hold people,” Chicotel says.

Technicians' Tips

A wirehouse rep (whose firm did not want him named) saw something ominous Aug. 9, 2000. It was the day after Cisco announced positive quarterly earnings. “What caught my attention was that the stock opened on well above average volume,” the broker says, “but closed right near its low for the day — and also below where it had opened.” That was the first in a series of sell signals.

Meanwhile, Sun Microsystems was continuing to post higher highs, but on “precipitously lower and lower volume,” the rep notes. That was a sign demand was drying up.

Point-and-figure charts alone would have put the upticks in share price into positive territory, the rep says, which is why he feels it's also important to keep one eye on volume.

If a stock is moving higher on above average volume, he might be a buyer, the broker says. But if the move is based on below average volume, “no matter how high it goes, I would more than likely wait for a pullback and better volume.”

That means never buying at a low, which clients may not always understand. This rep explains that he wants “to see a take-off on a sound base,” supported by higher volume. Otherwise, you could end up churning sideways in a trading range.

Another good technical check is sentiment, says Howell Foust, a rep with Morgan Keegan in Nashville, Tenn. Watch the two broad market indicators — the NYSE and OTC bullish percentages (available at, on a paid subscription basis), which gauge the relative degree of bullish sentiment in various sectors such as tech, banking and insurance.

“If the percentages get up around 70%, the risk is high,” Foust says, indicating a “tremendous amount of euphoria.” Conversely, a low percentage, around 30%, means that the risk is low, he says.

Sentiment is not a magic bullet, Foust emphasizes. Still, “the bullish percentages tend to draw you in down toward the bottom and tend to make you wary as you start approaching the top.”

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