Why We Broke the Rules
InvestingWhy We Broke the Rules
In 2006, Jack Schwager published a book entitled Market Wizards: Interviews with Top Traders. One of the traders he interviewed was Ed Seykota, a legend in the investment industry. One of the questions Schwager asked him was, “What are the trading rules you live by?” Seykota gave five short rules that govern how he manages investments. Two of those rules were:
“Follow the rules without question.”
and
“Know when to break the rules.”
Just two weeks ago, we published a blog post entitled, “Why We Use a Rules-Based Approach.” In that post, we discussed why we bought XRT, the retail sector Exchange Traded Fund, back in August 2020. Last Friday, the 29th of January, that position was sold. While it was completely intentional, it was also a direct violation of our rules.
You have likely heard about the “short squeeze” that we have been witnessing in GameStop (GME) stock. The stock started the year priced at $19 per share. At one point on Thursday, January 28th, the stock traded at $483 per share, an astounding ~2,441% gain in just four short weeks. The chart below is the daily candlestick chart for GameStop since the beginning of the year.
Chart: GameStop Corp – Symbol GME – 1 Day CandleStick Chart Source: Optuma Data from TD Ameritrade
In order to properly put this in perspective, here is the same chart but, this time, the data goes all the way back to 2002.
Chart: GameStop Corp – Symbol GME – 1 Day CandleStick Chart Source: Optuma Data from TD Ameritrade
There is much we could write on this topic, but how does this short squeeze apply to clients of Hicks & Associates Wealth Management?
Because GME is a component of the retail sector ETF that was, until the 29th, in a lot of our portfolios.
XRT is State Street Global Advisor ETF. As of December 31st, according to their Fact Sheet XRT had ~1.52% of its holdings in GameStop stock. Due to the meteoric rise in GME’s price, this position had grown to 12.37% of the ETF.
Source: State Street Global Advisors website
The Satellites that we hold in our portfolios are purchased based upon a momentum rule. Given XRT was already in our portfolio, and given its recent performance, our investment management rules dictate that we would continue to hold this position.
We sold.
When we wrote about our position in XRT just two weeks ago, we included the chart below.
Chart: SPDR S&P Retail ETF – Symbol XRT – 1 Day CandleStick Chart; Source: Optuma; Data from TD Ameritrade
Here is the same chart after Friday’s close.
Chart: SPDR S&P Retail ETF – Symbol XRT – 1 Day CandleStick Chart; Source: Optuma; Data from TD Ameritrade
We believe that eventually, GME stock’s per share price will fall back to a rational level and the short squeeze “game” (sorry, couldn’t resist) will be up. When that happens, and it could be soon, XRT will also suffer a drop in per share price. This is why we broke our rules – to lock in the additional ~20% move in this one ETF due to the GME short squeeze.
Seykota was right. It is important to know when we should violate the rules. We thought this was one of those times.
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Disclosure: Please note these are our opinions at the time of this posting and are subject to change without notification. Past performance is not indicative of future returns. This blog is provided for informational purposes only and should not be construed as advice. You should always discuss any decision with a properly qualified financial professional prior to any transaction.