Sunday, May 24, 2009

Equities: Keeping A Long Term Perspective

Effective cost-averaging seems to be a key element to long term equities trading success. A cost-averaging strategy may not necessarily be suitable for forex trading depending on the technical pattern you're trading, but I've found more often than not, in equities trading, it is more critical than what it's currently being given credit for.

During the whole equities market meltdown, I basically watched my stock portfolio - along with my self-confidence levels - dwindle to very scary levels. But as I have a cash account and I believe in the long term potential of the majority of stocks in my portfolio, I held onto all my positions, adding to positions that were trading well below their book value.

I respect Warren Buffett - who doesn't - but I have to agree more with Carl Icahn's strategy on buying up companies priced below book value. The reason I like this strategy more is that it inherently takes into consideration the debt a company is carrying already. So, if you're buying up a company way below book value, the probability of its stock price gravitating towards book value or slightly above book value is much greater. This often means fast money.

I'm the type of investor who is not embarrassed of buying only 48 shares in a company. So, I had a few very small positions right before the escalation of the global credit crisis. When stock prices fell below book value for a number of these companies, I added a few hundred shares of this and a few hundred shares of that at bargain prices.

I was not smart enough to buy at the absolute bottom, but at the least, I'm not completely out of the game yet. I plan on adding more shares for a few positions at Fibonacci retracement levels providing that it won't ruin the average cost of my shares.

Even if I don't get to add more shares, if my market theory is correct, I'll still be able to make a five figure profit on my full portfolio once the economic recovery accelerates.

Here's why:
  1. Stock prices tend to test 52 week highs and if the fundamentals are sound, they'll break these levels.
  2. Currently, my average price for each position is well below the 52 week high.
  3. Once the economic recovery takes place, which I am confident it will despite what everyone says, the only direction most stocks can go is up.
  4. Had I just left my portfolio alone without adding to positions, the economy would recover, but my stock portfolio would probably take years longer to recover.
  5. I'm therefore quite confident that at the least, I've put myself in a better position to recover my stock portfolio faster. And I am in a position to profit!

If you somehow feel anxious about your stock portfolio, I'd recommend constructing an Excel spreadsheet with the following information:

  • Company Name
  • Number of shares owned
  • Average cost price
  • 52 week high
  • Potential profit if you sell at 52 week high
  • 52 week low
  • Potential loss if you sell at 52 week low
  • Potential courses of action for each position

You will most likely notice that your portfolio is not as bad as it currently seems.

I'd also recommend moving your stops to lock in profits in this trading environment. If your position is already down by over 50%, that is not the right time to use a fixed stop. Instead, I would either look to reduce the position at retracements, or adding to the position if the downwards momentum seems to be turning around. If you add to your position, ensure that you're doing it in an advantageous way. This means:

  1. you should not be adding to your position if you're trading on margin
  2. you need to know when to stop adding to your positions
  3. you should have more shares at lower prices
  4. your average cost needs to be at a realistic level and below key technical levels (i.e. targeting 52 week high, targeting the share price's return to book value, or even targeting a Fibonacci retracement of the 52 week high)

Like always, do your own homework and do not take this to be investment advice.

I'm working on a similar money management strategy for forex trading and when I have any new breakthroughs, I'll post it here.

No comments: