In the Comments section of the latest installment of my "What Next To Buy, And Why?" sub-series of the My Mad Method [MyMM] process of selecting stocks to add to my portfolio, several readers asked me how I went about setting limit prices for stocks I was looking to buy. A commenter with the username "kolpin" asked:
"How do you decide on the perfect number for your limit orders? Do you choose it according to dividend yield or look at historical prices, or just set a price which will get the order filled?"
And shortly thereafter, another commenter with the username "Iwant2fly" chimed in with:
"I would interested in knowing how you determine a purchase price for your limit orders also. Sounds like a new set of articles!"
So I thought, "Why not?" Maybe not a set of articles, but I figured I could coax one article out of the subject, for what it's worth.
I've read from a number of well-respected Seeking Alpha Contributors and Commenters that they believe one should wait to buy any shares of a stock one is interested in until the stock has reached a "fair" or, better yet, "undervalued" price. I agree with this in principle, but I find it hard to accomplish in practice sometimes.
I do not have the patience of Job to place a limit order significantly lower than a stock's current price and wait for days, weeks or longer until that price might be met and my order filled. I have hypertension (aka, high blood pressure), Adult Attention Deficit Disorder [AADD] and more than a bit of Obsessive/Compulsive Disorder [OCD]. Which means that once I've identified something that I want to implement, it is extremely difficult for me to not fret over and fiddle with it until I achieve my goal, to the distraction of anything else I might or should be working on at the same time.
And my ultimate goal is to acquire the stocks that I've identified as the next ones I want to add to my portfolio; the next ones that will improve the overall yield of my portfolio and bring me that much closer to reaching pre-retirement nirvana, whereby I can relax in the knowledge that the portfolio I've accumulated by the time I retire will generate enough income in the form of dividends and distributions to replace my at-that-time paycheck so that I can finally retire. The stress and anxiety brought on by wondering whether the price of the stock I want next will come down to meet my "fair value" limit price is just not worth it to me, personally. So, what to do?
While I do want to acquire shares of stocks at a "fair value," what I have done in my particular situation is to adjust what is "fair" to me, in my terms. I certainly don't want to over-pay for anything if I can avoid it; I like a bargain as much as the next guy or gal. (Man, you should see my wife negotiate prices!). But at the same time, I have no idea whether the market is going to continue to go up in the near term, or whether there will be a pullback of such magnitude that I will realize a dollar off the current price and achieve undervalue bliss.
As far as I know, over the long haul, the market always eventually goes up. Always (eventually). It has its ups and its downs, and you might have to wait around for it to resume its historically upward trend, but I've got at least 15 years to go before I retire, probably more like 17, and then (hopefully) at least another 15 to 25 years or more after that wherein my investments need to keep me fed, clothed and housed. That's a minimum of a 30-year future life of investing, and hopefully something more like 40+.
So in the grand scheme of things, does it really matter tomorrow if I waited around for a couple of weeks or longer today in order to maybe shave a few percentage points off of the price of a stock I'm looking to buy and add to my collection just so I can pat myself on the back for getting the "maximum value" out of it? To my way of thinking, it does not.
So here's what I do: After consulting my copy of the MyMM spreadsheet in the usual manner to pick the company or companies in which I wish to invest my next available passel of cash, I go to my brokerage account's online tools and check the 6-month bar charts for those companies. In my case, this means Interactive Brokers, but I'm going to assume that most online brokerages' tools behave in a somewhat similar fashion.
Now, the process of narrowing down the choices I've laid out for myself in my "superlist" of potential companies in which to invest (which is a combination of my current wish list and my portfolio list) to the final candidates for my next purchases is not an overnight one. Typically I've been watching all of the stocks on my superlist for weeks, monitoring their MyMM Ranks, prices and whatnot. Not obsessively (OK, maybe a little), but regularly; investing is my new hobby, and I'm still having fun with it. As part of this process, I consult the 6-month bar charts for the stocks I'm most interested in, so by the time I've narrowed my choices down to my certainties, I've got a pretty good idea of what their charts look like. If any of them has taken a big jump up in price recently, I've probably factored that into whether I want to buy it in the first place, but some stocks have been on a steady climb for months, so waiting for some possible potential future pullback that might or might not occur doesn't suit my needs or disposition. What I'm now looking for is what they've been up to lately.
As I look at the 6-month bar charts of each company, one of the things I'm interested in is the stock's overall recent trend; has it been shuffling around in a relatively narrow range for the last few weeks or months, or has it shot up in price or taken a nosedive because of some event or another? And, does that matter to me, one way or the other?
Let's use a few of my most recent purchases, which just got filled this past Monday, as examples.
Below is the most recent chart that I have for Staples, Inc. (NASDAQ:SPLS). As you can see, things have not been going too well for this office supply stalwart in the last 6 months, with a couple of noticeable drop-offs in its price (correlating to recent earnings reports). However, in the near term, things have picked up for SPLS, if just a bit.
(The green horizontal line on the chart represents my current cost basis in SPLS, and since I didn't think of writing this article until after my most recent purchase, it's not where it was Sunday afternoon when I placed my limit order for Monday morning. You'll also note the price in the yellow box on the rightmost axis, which is the after-hours price on Monday night, as I write this article. Pay no attention to the price in the yellow box.)
The next thing I want to know is, within what range of prices has SPLS been trading in the most recent days? SPLS had been floating around the same range of prices for the last 7 days or so, and I had a suspicion that the market was due for a little downward movement come Monday morning, so in general I was looking for the lower bounds of the recent trading activity. By placing my cursor over the bars from the most recent day's trading activity (Friday), I get a pop-up window that tells me for that day what the opening price was, what the high and low prices were, and what the closing price was. This data is shown in the grey box superimposed on the diagram above.
Based on what I see there, and the previous day's close, I'll try to pick a limit price that is in the lower range of the previous days' trading activity for my limit price. If the stock (and the market in general) is trending downwards, I'll get more aggressive on picking a lower price, but I usually want the order to get filled quickly, so I don't go too far below where it's been trading in recent weeks, and stick pretty close to the low from the previous day, or previous few days.
Last Friday, SPLS opened at $12.44, and that was its high point for the day. From there on, it went down to $12.19, then rallied a bit to close at $12.36, not too far from where it opened. But it was that range that I was most interested in, and how far down it got during the day's trading. Based on that information, and my "gut" telling me that it would probably do something similar or, hopefully, worse on Monday, I set a limit price of $12.21 to buy my next block of SPLS.
I am currently living in Mountain Standard Time [MST], which means at this time of year, I'm effectively on Pacific Daylight Time [PDT], which means if I want to monitor the market when it opens, I will have to get up very early, collect my morning caffeine, and get logged on to Interactive Brokers before 6:00 AM. I am not a "morning person," so I usually don't get up to monitor the opening of the market. This is one reason I place limit orders for what I want to buy the night before the day I want to try to make my acquisitions.
So, sometime after 8:15 AM on Monday (let's just leave it at that), I shuffled into my home office to check the status of the limit orders I had placed the night before, including SPLS. To my wonderful surprise, my order had been filled at $12.21, and SPLS was already higher than that. In fact, SPLS closed Monday at $12.35, meaning I was up $0.14 on the very first day of owning this block of shares. Woo-hoo!
Seriously, though, it was a great feeling, a minor victory for me. I had placed a limit order for a price that was below the previous day's close (not a lot, but enough for me to feel like I was attempting to get a "fair" price for my money), and SPLS closed above that price that day. I'd gotten what I wanted to buy at the lowest price that I could manage during the day. What a great feeling!
But what if SPLS had closed lower than my limit price on Monday? To be honest, that would have been OK with me, since I managed to pick up this block of shares below Friday's close, which was really all I was shooting for. That was the cake; that SPLS closed above my asking price was the icing.
If you read my article from Monday, you'll know that SPLS wasn't the only thing that I placed limit orders for. I went through a similar process on Sunday night to place orders for BreitBurn Energy Partners, L.P. (NASDAQ:BBEP), ConocoPhillips (NYSE:COP) and Crescent Point Energy Corporation (CSCTF.PK), as well. Here are Friday's prices plus the limit order I set for them on Sunday night, what I ended up buying them for, how they ended the day on Monday, and the difference between where they closed and what I bought them for:
So, not bad. I can live with these results.
One thing you'll notice is that the price I bought CSCTF.PK for is not the limit price I had set. CSCTF.PK has jumped up in price recently, but despite that I felt the time was right to pick up some more. When I checked how things were going first thing Monday morning, the orders for BBEP, COP and SPLS had all been filled, but CSCTF.PK had not. Seeing how far it would have to come down to meet my limit price, and that it was already down a decent amount from Friday's closing price, I decided to "cheat" my system and override the limit price I'd set for CSCTF.PK with the current "Ask" price at that time. I didn't have time to monitor its price progress during the day due to commitments for my day job, so I went ahead and just bought it for the price it was at when I checked it in the morning. Considering the relatively small number of shares I was trying to buy, the difference between where it was and my limit price represented just "a few bucks" difference; let's say less than the cost of taking the wife out for dinner. I was therefore very pleased that it ended the day higher than my "cheat" price.
I realize this might not be "the best" method of picking the "best valuation" for an entry price, but it works for me. Sure, over enough time I may have "cheated" myself out of enough cash to make another small purchase of something, but it's not worth the anxiety of waiting through market fluctuations for me to do it any other way.
I started writing this article on Monday evening, September 24th, but wasn't able to complete it before having to turn in for the night. The next day, Tuesday, September 25, saw the market take a bit of a nosedive. Here are the four stocks I picked up on Monday, and how they fared at Tuesday's close:
So, even though everything went down today, the differences between where I bought them on Monday and where they closed Tuesday isn't as great as the difference between where they closed on Monday and where they closed on Tuesday.
Am I upset that these prices have dropped so much in just one day? Not really. Sure, it would have been better if I'd waited a day and made my purchases during Tuesday afternoon's round of trading, but there's really no way that I could have known that the market would tank as much as it did the very next day after I bought these stocks. I try not to cry over spilled milk; I think that all of these stocks will recover in the weeks and months ahead, if not by the end of this week, even. So, I'm still content that I got in when I did, and will continue to use this methodology of selecting my limit prices to make future stock purchases.
But that's just me; your mileage may (and probably will) vary. Do what makes you comfortable with your decisions to buy, or sell, and best of luck with your investment choices!
Disclaimer: I am not a professional investment advisor or financial analyst; I’m just a guy who likes to crunch numbers and can make an Excel spreadsheet do pretty much whatever I want it to do, and I’m doing my best to manage my own portfolio. This article is in no way an endorsement of any of the stocks discussed in it, and as always, you need to do your own research and due diligence before you decide to trade any securities or other products.