Re: Investing-Exit Strategies/When To HODL.

Imho, in the investing game, buying something at a cheap price is relatively easy to do. Knowing when to SELL is MUCH harder.

This thread addresses 4 categories of Exit Strategies and when it’s appropriate to HODL.

The 4 Exit Strategies are: 1) Replicating Portfolio, 2) Event-Driven, 3) “Greater Fool” Backed By Fundamentals, 4) “Greater Fool” Backed Only By Technicals. Let me explain.

When I started my hedge fund career, I was very attracted to strategies that do NOT depend on a “Greater Fool” to take you out at a higher price. Categories 1 & 2 fall into this category.

1.Replicating Portfolio – this primarily refers to option or convertible-based strategies that involve dynamic hedging to create a “replicating portfolio” (the very basis of Black-Scholes). The undervalued asset in question here is generally “volatility.”

If you can buy implied vol cheaply enough and then dynamically hedge (“scalping the gamma), you WILL extract value without the need for a “Greater Fool” to pay a higher price for your option/convertible.

2.Event-Driven. This covers a broad swath of strategies from risk-arb to distressed to owning bonds; what they all share in common is that value is being extracted via explicit EVENTS, whether they be merger closings, restructurings, coupon/div payments, principal payments.

Both of these categories obviate one of the hardest parts of investing, which is to simply “Buy Low/Sell High” – with the “Greater Fool” presumably paying you the higher price.

Things get much harder once you venture into Categories 3 & 4, because you need a “Greater Fool” to pay a higher price than you to make money, and the market is full of smart people ALL looking for their own Greater Fools.

3.“Greater Fool” Backed By Fundamentals. This pretty much encapsulates most directional investing based on fundamental analysis. Whether you go long or short, you are deriving conviction based upon some notion of intrinsic value grounded in financial analysis.

Cash flows, capital structure, valuation — these all matter. And when you’ve done your homework and Mr. Market pukes & marks your position down, you have conviction to add because presumably the other “Greater Fools” will eventually come to the same fundamental conclusions.

Even if they don’t, companies that are good stewards of capital will recognize their own gap to intrinsic value and address it through dividends, buybacks, recaps, spinoffs, other value-unlocking activities, etc.

In other words, Category 3 can become Category 2 when Events come into play. Activists try to force Category 3 into Category 2.

4. “Greater Fool” Backed Only By Technicals. The hardest regime, imho, is when you’re taking a position based purely on technicals/momentum either because the underlying asset is impossible to value fundamentally or because you’re too lazy/ill- equipped to do the work.

Don’t get me wrong, some of the greatest traders and Market Wizards do nothing BUT Category 4. But the key to success in this category is STRICT RISK MANAGEMENT and having STOP-LOSS limits. Trading futures, crypto, momentum/meme stocks all fall within Category 4 imho.

Because there is no fundamental/intrinsic value backing up the thesis, you are 100% reliant upon the “Greater Fool,” and unlike Category 3, there are fewer ways to turn this into Category 2 (crypto guys might point to “halving events” as examples – I find this tenuous).

Now comes the question of how a “HODL” mentality mixes with all this as well as when to sell on weakness vs. when to add on weakness.

I believe HODL/adding on weakness only works for Categories 1-3, because you can only truly derive the CONVICTION to HODL/add to an asset (especially if it’s volatile) if you have well-defined exit-strategy parameters (replication, event, fundamental valuation).

When you don’t have any of the Exit Strategies of Categories 1-3 and you are 100% reliant on the “Greater Fool” to pay an ever-increasing price, you have to ask yourself: 1) What would make that Greater Fool to do that, 2) what happens if the Greater Fool changes his/her mind?

This is why I think any levered and/or hyper-volatile asset that has no FUNDAMENTAL value or built-in EXIT STRATEGIES (Categories 1 & 2) make extremely dangerous “HODL” assets. BTC/crypto, meme stocks, futures all come to mind.

I’ll end this thread by saying that I think some of the most grievous financial injuries come from HODLing/dip-buying of Category 4 assets, when this strategy should only be used for Categories 1-3.