Leading Off…

April 09, 2014

Tim Reazor
Chief Investment Strategist
NorAm Asset Management

Continuing the theme of what’s not obvious in the markets – I’m going to talk over the nest two newsletters about scaling into a long or short trade.  Proper scaling into an investment or trade actually reduces your over all risk in the markets.  First up- the long trade.

How many of you plunk down your entire position all at once?  If you have $10,000 to buy shares of XYZ stock you’re buying $10,000 worth all at once.  Does this describe you?  If so, the next time your buying stock long try the following.

Reward success.  Meaning – if you’re looking to build a 10k position in a stock start by buying 50% of your total position.  If the stock closes higher you’re free to buy more.  The next day buy 30% more of your position.  If the stock closes higher again you’re then free to complete the last 20% of your position.  What did you just do – average up or as I call it rewarding good behavior in a stock.  Why would you want to do this?

Risk control.  If you’re building a position  – and this assumes that you’re working with the top 2% of the most fundamentally and technically sound stocks – you want to buy strength.   If you buy 50% of your position and the stock goes down – sound like you J – why reward the stock with more of your money?   How do you know it’s going to come back? What if the move down is a more serious issue?  How do you know that you’re not buying a top?  You don’t – you may be cautious and have fact-based reasons to be cautious, but no one pegs exact tops or exact bottoms.  This is why you need risk controls.

Imagine if you put down 50% of 10k and the stock dips 5% over the course of the next week – that’s only a $250 dollar loss compared to a $500 dollar loss if you had put down your entire position at once.  In a choppy market like this one how many false steps do you think there will be in stocks?

Let’s examine four stock purchases.  If you lose 5% on three stocks in a row on your 50% of 10k position you’ll have lost $750.  If plunked down your 10K for all three you’d have lost $1,500.   If on the fourth purchase you make just 10% to the upside on your average 10K position you’ll have lost on three out of four stocks and still come out ahead.  If you’re a plunger you’ll be in the hole $500.

You can become wealthy over time with risk control.

If you need help with your investing discipline please let us know – we can help you navigate these choppy markets.  Email me at [email protected] to set an appointment – either in person or online.

I talk stocks and markets most days on twitter – follow me by searching for my handle – @TJReazor

Best Regards,