Portfolio Strategy: Learned And Tested

by: Brian Sanders


Investors should not overly diversify. Focus on your best ideas.

Attempting to time your entrance is key. Technical analysis and news-based reactions are helpful.

Slowly building a position in increments is very effective. Averaging down is usually better than averaging up.

It seems that investors in general have a tough time creating positions in their portfolios simply because it "isn't the right time." No one can gauge when any market player will enter or exit a position, so it's simply a matter of being flexible with the market. Flexibility is all a matter of perspective; I do not think price is equivalent to value, however, investors need to be realistic with their entrances (for traders, this is absolutely necessary). A person can have their security selection down, but lose on the level of asset allocation. Finding the "bottom" is entirely based on luck, although we can get very close.

Asset Allocation

Whenever I buy stock in a company, I want to have a relative idea that its bare minimum slight undervaluation (i.e. 10% or more), the larger the margin, the better. After researching, analyzing, projecting, and finally developing a valuation, it makes sense not only to make sure this margin of safety exists, but also keep relative exposure limited to start. This literally gives you double protection on both a fundamental and volatility basis. For instance, say you want to invest $10,000 in company XYZ at $10. What is the best idea for allocating capital into the position: all at once, 5% or 50%?

Well this is relatively subjective, but what seems to work most effectively is generating positions in either thirds or fourths. The reason for this is provided XYZ is 10% undervalued and trading at $10, there are two outcomes: it will rise or it will fall. If you enter your entire position at $10, you could potentially be a serious victim of volatility, where it drops to $9 tomorrow. On the converse, say you only buy 10%, but it spikes to $12 on market news - well you just missed out on good upside. In other words, you want to have a happy medium of putting enough in to take advantage of upside, while maintaining the option of averaging down if you so choose.

Another simple but very effective feature of this strategy is as you average down, not only does your cost basis get reduced, but you now have a much higher exposure to upside - basically a multiplier. Yes you do increase exposure to the downside, but it is assumed that a stock price will not head down indefinitely. That's why it's useful trying to time your incremental positions.

Thought Process on Timing

Timing is probably one of the hardest things to do in the market. Every market participant attempts this. Regardless of whether you are a scalping trader or a long-term investor, you want the best bang for your buck. Through continuous observation of markets, charts, and price action in general, you can almost get a feel of how sentiment is within a stock. I am not talking about timing based on emotion, but actual behavioral psychology of the markets. Two common tools that I use to time an entrance (excluding fundamental-based ones) are technical analysis and news-related information. They actually help objectify prices instead of guessing when to make a transaction to buy, sell, or short.

Slow sell-offs and subsequent gaps: Most people believe that gauging short-term price movements is nearly impossible; I tend to think otherwise. More often than not, whenever these three events of price action develop in a row, the same ending typically occurs, comparable to a phenomenon known as "fill the gap." Provided the fundamentals of the business have not changed significantly, or are not permanent, this is a very useful tactic to implement. Basically when a slow sell-off occurs, followed by a measured move, and final forming consolidation, investors should initiate a position. The idea is that the price will rebound at least to the start of the extended move, and sometimes back to the 'sell-off' stage. Provided below are multiple instances of this type of price action occurring in charts of VALE S.A. (NYSE:VALE), Procter & Gamble (NYSE:PG), and Coca-Cola (NYSE:KO): Click to enlarge

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Those are just a few examples, and to me it seems to be one of the safest types of price action both traders and investors can take advantage of. Keep in mind, you must be very objective with yourself when generating this type of observation. It is not a precise science, but it must be clearly visible for the broader market, hence why strong bullish movements occur afterwards. Most of my timing is generated through multi-level technical analytics using: MACD, Stochastics RSI, MFI, Derivative Oscillator, Vortex, and DMAs.

News-Related Information: Depending on the business, sometimes what appears to be bad news is just another opportunity for investors to grab a piece of the pie. I have seen this time and time again, where in a single day, shareholders will dump continuously from the market open until the close only to see shares rocket directly afterwards, possibly for weeks or months, never seeing that price again. This seems to be especially prominent in businesses that are undervalued, either still growing, turning around, or what have you. So if one of your top three picks misses the bottom line through analyst estimates no less, view it as a potential opportunity to grab more (this is where I find bullish moving averages to be very useful).


I could go on and on about different situations regarding short-term market movements, analyzing the past to predict the future, but really it is up to you to find the right price. Invest in businesses that are profitable and have a bright future ahead of them. Try to time your positions the best you can, preferably with selling prior, and slowly build your positions over time. I have implemented this strategy myself, and I think you should too.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: VALE is on my watch-list.