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 Tim.Reazor@NorAmAsset.com 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