The short answer
It’s important to distinguish between looking at prices, which I think you should do every day for any individual stocks you may own, and measuring performance of your actively-managed securities (including ETFs and mutual funds) vs. the benchmark you have selected. Under normal circumstances, I think you should do the latter only once a month or even once a quarter, unless you think something is going seriously wrong with your investment plan (how to tell if something is really going wrong will be the subject of a later post).
Looking at prices
Why look at prices every day? Yes, I think it’s true that daily or weekly price movements of individual stocks can be statistically best explained as “white noise,” or random, informationless progression. Still, looking at prices will, as time goes on, give you a sense of what an individual issue’s typical daily fluctuation is. That, in turn, can give you the ability to judge that a price change is abnormal and potentially information driven.
Remember, investing is a craft skill, sort of like baseball or carpentry or shoemaking. It’s all about learning by doing. In this case, the more you prices you look at, the more chances you have to see–and to be able to generalize about–what is normal and what is not.
An atypical price movement, especially on unusually high volume, often means that another market participant has developed new information that is causing him to buy or sell the stock in a very obvious fashion. So you should at least make an attempt to find and evaluate the new data.
Risks to doing more than look
It’s important to look but there are a couple of dangers that you have to deal with in doing so. They revolve around being caught up in the moment and forgetting your long-term plan:
–you may get scared and sell based on price movements that turn out not to have been a warning about upcoming poor company fundamentals, but rather just a series of random price fluctuations–or someone acting on information that later proves false;
–you may begin to transact more or less randomly because you’re getting daily information that focusses you on the trees and away from the forest.
–worse, it’s possible that you sell a good stock prematurely, forgetting its longer-term potential, just because it has done well so far.
War stories (sorry) to illustrate these points
1. A couple of years ago, I owned shares in a Canadian oil and gas royalty trust, something not characteristic of what I usually do. But the stock had gone down a lot before I bought it on an unfavorable government tax decision and it had a yield of 14% for the next several years. The stock traded maybe half a million shares a day. Late one trading day someone came into the market with a market order to buy a million shares. The order was filled, at a price 10% higher than the previous trade.
As it turns out, two or three weeks later a Dubai sovereign investment fund bid for the company at a 20% premium to the big buyer’s cost.
Not every information-based trade is as unsubtle as this one, which looks to me like it was done by someone itching to serve jail time, but they happen more frequently than you’d think (most institutional buyers set limit orders, don’t show all they have to buy to a broker at one time, and want to be no more than 25% of the daily volume so that they don’t move the price).
Of course, we’re usually more interested in negative price anomalies than positive ones. They’re harder to read (more in my “going wrong” post) but the main thing is to start gaining experience by looking. As Yogi Berra might have put it, you can see a lot that way.
2. In my first year with a full-time portfolio management job, I created a plan and formed a portfolio in the beginning of January. I spent a huge amount of time thinking about my stocks during the year and tweaked the portfolio constantly as new information emerged in the market. After all my sleepless nights and intense effort I was about 100 basis points ahead of my index by the end of October.
It was then that my boss’s boss gave me a tremendous gift. He didn’t intend to. I think he just happened to be in a grouchy mood. What he did was this:
He asked the IT people to calculate what the performance of my original January 1 portfolio would have been if I had done no trading during the year, but left it completely untouched instead. In other words, what would my performance have been on the assumption that I had just left the office in New Year’s Day and not come back until Halloween.
The results? The January 1 portfolio was 200 basis points ahead of the index. In other words, all my agonizing, all my activity had lost the firm 100 basis points, or over $1 million.
How embarrassing!! I quickly learned–not from the big boss, though– that this is the norm. Almost everyone trades too much, trades on short-term information and those trades end up losing money. Who benefits from this? –the broker who charges a trading commission, makes a market in the security and may well even be the other side of the trade. Check you brokerage website. Where are the tools that allow you to figure out whether your overall trading has gained or lost you money vs. your selected benchmark index? There are none. Why? The broker makes more money if you trade than if you don’t. So it’s not in his best interest to enlighten you.
3. I had a junior colleague for a while who was very good at analyzing medium-sized growth stocks but who always wanted to sell after a 20% rise. The sell recommendation would often come with a (wacky) plan for trading back into the stock at lower prices. This is the “common sense” approach–but it’s almost always wrong when dealing with growth stocks. The flaw–what happens if the stock doesn’t accommodate you? How many idiots do you think there will be who will foolishly sell this sure-fire winner down 10%, all the while the story is becoming recognized and the stock is rising, just so that you can buy it back?
For example, at one time we researched and bought a stock, call it XYZ, at $18. It quickly ran to $22, as other investors began to discover it. My colleague said we should sell it and buy it back at $20. I refused, so we did nothing. The stock dropped to $21 but then reversed course and ran to $30, where my colleague, dazzled by a 67% profit in a few months, argued in the strongest possible terms that we should sell it all. Again, we ultimately did nothing. The stock peaked about two years later at around $140, meaning my colleague would have left over 90% of the profit potential from this purchase on the table.
If looking at daily prices gives a professional–admittedly, in this case, not a very good one–an illogical desire to sell a perfectly good growth stock, it must require a lot of discipline for a non-professional looking at exciting price movement to avoid the same mistake.