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Anatomy of Tax Loss Season

Posted by Eric Coffin

on Thursday, 09 November 2017 13:13

It’s that time of year again.  Stocks you follow seem to fall for no reason.  Issues that recently had great looking market depth, with lots of bids stacked up below the current trading level suddenly seem orphaned.   Where did all the buyers go?   Yep.  It’s tax-loss season.

This time of year, traders are going through their portfolios (or they should be) deciding which holdings, if any, should be sold to generate capital losses that can be used to reduce total capital gains for the year or carried forward to be deducted against future gains.  Tax loss trading gets the most media coverage, but tax gain trading can also influence the timing of trades.  Some traders prefer to hold large winners into January – if they don’t think they are going higher – to defer the recognition of the gain until the next tax year.

So just how big a thing is tax loss season, and should it inform your own trading decisions?  The influence of tax loss selling will increase with the volatility of a given stock and decrease with the liquidity.  Put more simply, stocks that have had the biggest price moves earlier in the year, more specifically stocks that had large positive moves followed by big drops in price, will see more tax loss selling.  Stocks that have less trading volume will be impacted by tax loss selling the most in terms of percentage price change, as there is less liquidity to absorb it.

ericnov17

You certainly see the impact of tax-loss selling with individual stocks, and it’s larger with smaller, low liquidity stocks like those that dominate the TSX Venture index.  Even so, tax-loss trading is only one of many influences and only impacts shares that have already seen large price drops.  If you look at the 10-year chart of the TSX Venture Index above, you’d be hard pressed to pick out late year moves based on tax loss selling. 

 So far, this year, we’ve been on a weak uptrend for several months.  Those tend to last through tax loss season, or most of it, though we might see a small dip in December.  Note again however that there are many other factors that can overwhelm this effect, at least at an Index level.  If New York crashes, it takes everything with it.   If there is a giant new discovery or a new sector heating up that can also swamp the effects of tax loss trading at a market wide level.  You’re better off focusing on individual stocks in your portfolio when deciding when, and if, to trade tax loss season.

Some thoughts on what to trade and when:

  1. The Early bird gets the worm on the sell side, the late sleeper gets the deals on the buy side. -  Tax loss selling seems to start and end a bit earlier every year.   “Pro” traders, like brokers, who are taxed at the full rate for gains and losses, seem to be particularly diligent about selling early.  Many of them started last month in fact.   There are always stragglers though, so if you’re trying to buy on a “tax loss dip” you may see the best price in early December.
  2. Selling doesn’t have to be forever but its even more important to be early. – You can sell to generate a capital loss and still own the stock again later.  You must be completely out of the stock for at least 30 days before buying it back, though.  That means its best to sell early – and you should check with the company.  If you’re going to be out of the stock for a month, try to make sure there are no important developments on the horizon.
  3. For explorers, seasonality is a big factor.  We’ve seen several companies exploring in Canada’s north getting their share prices savaged after putting out fair or even good results.   Traders sometimes sell hard even on good news if they don’t expect anything material for several months.  It’s a late year for results because of analytical lab delays. There are a number of companies with northern projects that will be releasing results for a couple of more months. That might delay tax loss selling for some but keep it in mind.
  4. You can always wait and book losses for next year, or later.  Look at what gains you need to offset, if any.  You don’t need to sell if don’t have or want to offset gains.  But, before moving on,  ask yourself  “would buy this stock  at this price if it was offered tp me today?”  If the answer to that question is “no”, it may be a good idea to sell just for portfolio management and simplification reasons.  I’m much better at buying than selling myself so I try to force myself to sell occasionally.
  5. You’ve got until Christmas Eve, but few wait that long.  Take position size and liquidity of a particular stock into account.  If you’re trying to sell 200,000 shares of a stock that trades 40,000 shares/day be prepared to be patient unless you’re happy knocking the price down heavily and getting a terrible price.   Likewise, if you’re thinking of buying the dip during tax loss season on a stock that doesn’t trade much be prepared to put in “good until cancelled” bids and don’t wait until mid or late December.  Even stocks that are heavily hit by tax loss selling usually bottom out early in December.

Good luck and good trading. 

Eric


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