The Wisdom of Half Positions 42 comments
-
Font Size:
-
Print
- TweetThis
What I am going to talk about here is annoying to some who always feel that investing is about taking bold actions. I had one boss who would go nuts when I would talk about this strategy. Other friends, akin to deep value investors, would get perturbed as well.
I used this strategy extensively when trading corporate bonds between 2001 and 2003. I was a fairly active trader, unlike what I do with equities today. Yet, even with equities, my rebalancing trades which have aided me in this volatile market mimic some of the benefits of this strategy. Here are some examples:
1) Say you bought a stock and it rapidly rallies, yet not to the point where you think it is at fair value. Perhaps recent events have made you re-estimate fair value upward. What to do? Sell half of the position, and wait. If the price falls, buy back the position. If it rallies further, sell the rest.
2) Say you want to buy a stock, but it is plunging like a stone. You’ve done your homework — the balance sheet is strong enough to self-finance the company for three years, estimated earnings for the next indicate the company is cheap, what to do? Buy half of a full position, and wait. If the company rallies sharply, sell the position. If it continues to fall, wait until it stabilizes, confirm your fundamental research and buy up to a full position.
3) Say you like a stock, but it has rallied past your buy point. What to do? Buy half. If the stock comes back to the buy point, buy a full position. If it rallies further, sell the position.
4) Same as number 3, but reversed for shorting.
I would almost always scale in and out of positions as an institutional investor, rather than doing it all at once. I credit Jim Cramer for teaching me this. The real Jim Cramer is not the “lightning round, ” but the guy who scales in and scales out. The lightning round is binary — buy/sell. The real world is more nuanced — how much to buy and when?
But the real benefit of doing half is the psychology of the situation. Many investors suffer from fear, greed, and regret. Doing half short-circuits those responses. When the stock price moves in favor of profits, be glad of those profits. When the stock price moves against profits, reanalyze and either a) go flat, recognizing your mistake, and being grateful that it was small, or b) increase the bet to a full position, and be grateful that you didn’t put a full position on initially.
Scaling in and scaling out gives freedom to investors, and removing many of the psychological burdens that they bear. It doesn’t mean there won’t be losses. There will always be losses - but they will be easier to bear, with no panic that leads to selling off at the lows, or buying at the highs.
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
David Fry
-
2
TraderMark
-
3
Don Dion
-
4
Cliff Wachtel
-
5
Mike Havrilla
Top Instabloggers » -
1
-
Top StockTalkers
Top
StockTalkers.-
1
David Fry
-
2
Cliff Wachtel
-
3
Mike Havrilla
-
4
David White
-
5
Hedged In
Top StockTalkers » -
1
This article has 42 comments:
Not only that. With the current volatility never been seen after the 1929 to 1932 stock market meltdown. Stocks can easily go 2x to 10x in some instances. This may not happen again in our lifetime - just like the 1929-1932.
Buy during sell-off and sell half the position at 2x or more. Then hold the other half for 3 to 5 years and sell them at 5x, 10x, 20x or more depending on how crushed those stocks have been hammered.
No need to worry if those companies going bankcrupt. Selling half at 2x or more will make the other half "risk free".
For example:
When ABK was analysized to have zero value in June/July 2008; I bought ABK and MBI based on those news then sold some of them at 2x, 6x and 10x. Then bought them back on the next plunge. No need to worry if they go bankcrupt or what. AMR and JBLU also got damaged heavily by the spiking oil price of $147. They went down like crazy and bounced up more than 2x as the oil price plunged to $35.
Shipping made delayed reaction to US economy, but when China went down, shipping got hammered. By Oct/Nov 2008, DRYS was more than 90% cheaper. Going with DRYS and DSX were great positioning. DRYS jumped a lot more than DSX and I was more than happy selling 2/3 positions and buying them back on the next expected dive. Also made some profits in the process same with ABK and MBI.
The last plunge of March 2009 is godsent. Lots and lots of stocks going more than 90%. C, BAC, UYG, GE, AA, SOLR, EK, OMX, ODP, MSO, etc. After the initial bounce, they gained more than 2x run up.
There may still be one or more expected plunge in the coming months.
The problem is that those hammered companies are burning through their cash reserves at a rapid rate and may not survive more than 6 to 9 months.
So, fundamental analysis will have to play a bigger role than technical analysis by that time.
As opposed to completely exiting a position my preference is to sell "At the Money" covered call if in my opinion I have reached a short term profit target.
On Apr 21 10:16 AM GCherer wrote:
> What is a 'full position'? How is it determined?
The first example givien is this: "Say you bought a stock and it rapidly rallies, yet not to the point where you think it is at fair value. Perhaps recent events have made you re-estimate fair value upward. What to do? Sell half of the position, and wait. If the price falls, buy back the position. If it rallies further, sell the rest."
If I'm reading correctly, the position is still increasing in value, and your re-evaluation is that it is likely to rise more. Why sell? Why not wait for a turn downward (using a tight sell-stop) before selling? If the stock is still rising, don't you want to get that?
Someone educate me on this point. Thanks.
Your cost basis for this sale can be either $5 or $10 - your choice! You can say you sold the 50 shares you bought at $5 or the 50 you bought at $10. The shares are identical and indistinguishable. You just have to pick the other cost basis when you sell the other 50 shares. Thus, you can chose to pay taxes this year on your $500 in capital gains or on your $250 in capital gains. When you sell your other 50 shares, you'll have to use the cost basis you didn't use before.
Why might this matter?
1) Suppose you sell 50 of your 100 shares at $15 each. Should you pay taxes using a cost basis of $5/share or $10/share? Most of us would claim $10/share to pay lower taxes this year on a $250 profit, rather than taxes on a $500 profit (a bird in the hand, so to speak).
However, if your realized net investment losses for the year exceed the $3000 that the IRS allows you to count against your ordinary income (as is the case for many of us this year!), then it is in your interest to use the lower cost basis and the higher profit. The other losses will protect the higher profit from being taxed. Then, in some future year, you can use the higher cost basis to claim a lower profit and pay less taxes. Win-win. (keep a close eye on what your tax or accounting software is doing though)!
2) Suppose you are single and your income for 2009 was $33,950, right at the top of the 15% tax bracket. Each dollar you make over that amount, including short term capital gains, will be taxed at 25%. Next year, you expect to be laid off and earning much less income, so there's little risk of hitting the 25% bracket in 2010. If you take your bigger gain in late 2009, it will be taxed at 25%. If you take it in early 2010, it will be taxed at 15% (assuming both are short-term gains, for illustration). Of course, in this case you should take the bigger gain in the year you have less income.
Similarly, if you receive a big promotion late in the year that will push you into a higher marginal tax bracket the following year, take your bigger short-term gain while you are still in the lower bracket.
The inverse works for claiming losses to offset ordinary income, up to the $3k limit.
Marginal tax brackets:
www.bargaineering.com/...
3) Suppose you have owned 50 of those shares for over a year and 50 for less than a year and you are in the 25% or higher tax bracket. Probably you should claim the cost basis of the shares you bought over a year ago in order to utilize 15% long-term capital gains tax rates rather than 25-35% short term rates, even if this means claiming the bigger gain first. Then when you other 50 shares are a year old, you can do the same for them. The alternative is to pay a higher short-term capital gains tax rate on 50 of your shares!
4) Suppose all 100 of your shares are long-term and Congress raises long term-capital gains taxes, effective for the 2010 year. Assuming stock prices don't fall by an amount equal to the increase in taxes at the end of 2009, it makes sense to take your bigger gain in a year in which taxes are lower.
If you have losses, use your lower cost basis / smaller loss in the low-tax year so that you can offset more of your other investments' gains with your higher cost basis / bigger loss in the high-tax year.
Money (stock positions) are fungible. If I make 25% in a stock, I don't much care that I make the next 25% in the same stock or in 2 (after having sold half and reinvested).
As a matter of fact, selling half forces me to have to find a second stock that performs as well as the first. You know how what you have has (and may in the future) performed but don't really know how what you're getting into will perform.
Otherwise the whole scheme degrades into "doubling down", rather than "singling down", which would be the name for Case2 above. And everyone knows that doubling down is "bad" :-)
Another problem with the recipe is that it does not define clearly what "dropping like a stone" means (case2). What time-scale are we talking about? A day? A week? Two weeks? Percentages?
Perhaps the biggest problem with the system is that it is somewhat wooly and vague.
On Apr 21 11:55 AM Guru914 wrote:
>You know how what you have
> has (and may in the future) performed but don't really know how what
> you're getting into will perform.
If you think you know any more about the future performance of the first stock than the second, you are mistaken. "May in the future" is not knowing anything...it's flipping a coin. Saying that you don't want to track as many stocks is a valid rebuttal to this article, whereas your statement above is a VALIDATION of the article.
On Apr 21 12:47 PM CloroxCowboy wrote:
>If you think you know any more about the future performance of the first stock than the second, you are mistaken.
You don't know that's why selling half is a false notion of being conservative. It only makes some sense after a long bull market move as a strategy for incrementally moving into cash on all your positions on your way to being in "all-cash" at the end. Or, conversely, as a tactic for moving from "all-cash" into fully invested at the beginning of a market move.
Perhaps stating the strategy in the inverse - scaling up by adding to a successfully working position - makes more sense.
I think knowing when to exit or reduce a profitable trade is tougher. I found myself up 50% in Citi last week, but only had a 1/2 position. Instead of taking profits and waiting to buy again, I bought more on a small pullback. Now I am breakeven overall. Should have taken out my original capital, plus 10% profit, and let the rest of the house money ride.
Say you buy 100 shares of a $7 stock and your commission is $7 per trade. Your buy has to rise 2% before you can break even on your sale. Do a few half sales, and you'll quickly be nickeled and dimed.
The flip side is that if your emotions are playing a part in your decisions, then this might be good to limit your losses.
You bring up a good point and the answer has more to do with style than a 'right' strategy. If you are trading for a quick scalp, you bust in and out with a full position, which is usually small in the first place. If you are a momentum player, you buy high and buy again higher, which is what I think your position was. However, many active conservative investors don't really believe in momentum and want a strategy rings the cash register once a smaller profit is made (say 10-25%). This is best used in larger portfolios when you have a lot of moving parts and a track record to protect (i.e. like me). If I ran a momentum fund or leveraged hedge fund, I would probably scale in as the price increased. All are fine strategies, you just need to know before you click the mouse what you are trying to accomplish and not change you mind when it comes to your risk management technique. For the record, I do use all of these strategies, but for different set ups.
I hope this helps.
On Apr 21 11:10 AM David Van Knapp wrote:
> I have no trouble with scaling in and out of positions, bu I have
> a fundamental question: Why would you sell if the stock is going
> up? Wouldn't you want to keep riding it up?
>
> The first example givien is this: "Say you bought a stock and it
> rapidly rallies, yet not to the point where you think it is at fair
> value. Perhaps recent events have made you re-estimate fair value
> upward. What to do? Sell half of the position, and wait. If the price
> falls, buy back the position. If it rallies further, sell the rest."
>
>
> If I'm reading correctly, the position is still increasing in value,
> and your re-evaluation is that it is likely to rise more. Why sell?
> Why not wait for a turn downward (using a tight sell-stop) before
> selling? If the stock is still rising, don't you want to get that?
>
>
> Someone educate me on this point. Thanks.
I seem to be a nomad and go from broker to broker to take advantage of their 'free trades for a month' or sometimes go to the expensive ones if i want to stop myself from overtrading
Thanks for your explanation. I did some more thinking about it myself, and I reached a similar conclusion, that it's a matter of what you are trying to accomplish. You are correct, I was coming from the point of view of a momentum trader.
I also think that it's partly a matter of what timeframe you think is "investable." The article (and a lot of the comments) seem to presume pretty rapid trading, without actually stating that. But in fact, your "normal" or "comfortable" timeframe, or your policy toward booking small profits once you get them, is a strategic keystone, and there's no reason to assume that others are talking about the same strategy.
I made the same mistake myself when I posed my question: I presumed that the author and others were referring to a timeframe of several weeks minimum (i.e., what most call swing trading). My question was based on that unstated assumption.
Thanks for helping me clarify my own thinking.
For me, the first decision involves which portfolio I'm dealing with. If its the core portfolio, the decision of position size is made based on sector allocation and weighting. If its the trading account, its purely a matter of liquid funds available, and the percentage of that amount that I'm "comfortable" risking. Naturally transaction costs have a fairly large bearing on the profitability of trades, so I think its important to only enter trades that have a sufficiently large potential profit, compared to downside risk; otherwise a few "good" trades (i.e. profitable ones) may not generate enough profit to cover the losses that inevitably occur when trading (yes, I use trailing stops).
In terms of scaling in or out, as an example, I've got a fairly large position in a REIT in the core portfolio. I've had it for a couple of years, and it has run up quite nicely over the last few weeks, but like many (most?), I'm still somewhat leery of what the market might do over the next few weeks/months. Based on TA, I think it MAY run a bit higher, but no guarantees, so I've got a trailing stop that, if triggered, will sell 60% of the position. On fundamentals, I have faith the company is a "survivor", so I'm not totally exiting the position, just lightening up on the exposure, and would, in all likelihood, buy back in at a lower level, assuming a sharp market correction.
Any thoughts?
On occasions it may become necessary to repair a position that has gone bad due to a sudden change in the markets. A good example for this is the shipping sector and in particular DRYS. Say you had 200 shares purchased at $50 and the price suddenly dropped and you missed the opportunity to sell them at a decent price. You could have bought 600 shared at $4.00 for $2400 effectively reducing your average cost to $15.50. The price subsequently went back up to near $18.00 and one could have recovered from the loss plus a small profit.
On Apr 21 08:42 PM R0B50 wrote:
> It would be useful to see this strategy played in reverse for selling
> as well.
> Any thoughts?
Also what constitutes a whole position? Half of a full position of all your assets is way too much. Since a full position seems arbitrary, half of a full position isn't by necessity a derivative of that arbitrary value?
If you want to diversify, make sure you buy at least 8 positions roughly equal weighted that are not obviously correlated. If you want to limit your risk taking, control your asset allocation position in stocks purposefully and methodically, not by simplistic methodologies like this. And if you want to allocate your assets to winning stocks and lower your exposure to loosing stock, please do regular stock research on new positions and existing positions and allocate accordingly. Trading on past performance is a poor substitute to real research.
Every day you own a stock consider it a new bet and act accordingly. Too many people let their old positions slide without follow up research or don't buy because they view them as more risky than holding their current portfolio even when this often is not the case at all.
I don't mean to diss the author as much as try to be helpful to those seeking to make rational investment decisions.
This works realy well with broking like etrade where the brokerage is cheap. You can trade around a stock doing this, always making the most profit on the furthest moves.
This is not for large positions, better for trades around the $5000 dollar range.
I have been doing things this way for 50+ years and it has worked well over time. Jim Cramer has many good ideas and is worth listening to - even if you do not agree with him on everything that he recommends - you can learn a lot from him.
Larry Connors from TradingMarkets who wrote Short Term Trading Strategies that Work teaches this to professional traders. He calls it TPS (Time, Price and Scale-in) and he backs it up with over a decade of empirical evidence. Here’s the scale-in setups he’s recommended this year in his daily newsletter. 14 of the 15 ETFs he’s suggested have been profitable through yesterday.