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I’m a private investor who manages my own four portfolios, and a half dozen more for family members. My focus is long term, but I also trade some short-term opportunities. I'm fortunate to have worked for a NYSE-traded financial firm for the decade up to 2010, but I'm not an adviser and my... More
  • My Approach To Stock Investing, Part 2 10 comments
    Sep 25, 2013 8:17 AM | about stocks: EEP, GE, HAL, HCI, KR, MTW, OHI, TRN, VLO

    My Instablog posts expand on my overarching investment approach so that everyone who reads my opinions on specific stocks also has access to the general strategy behind each call. So, even though they're not usually repeated in each individual article, the strategies and tactics discussed herein apply to all of my stock calls.

    I hope that my writings are a helpful resource to complement the due diligence of other investors, but my writings are never intended to replace the due diligence that each investor should do.

    Here are parts 1 and 3 of these ramblings.

    1. When To Buy

    "The time to buy is when there's blood in the streets."

    ― Baron Rothschild

    One of my strongest opinions about investing is that when to buy is just as important as what to buy. In other words, one thing that gives retail investors advantage over the "pros" is that we don't have to buy stocks all the time. We can wait until the market inevitably provides its periodic fire sales, back up the truck and practically guarantee outsized returns. In fact, the "KISS" tactic (keep it stupid simple) is what I attribute most of my gains to, not any brilliance on my part.

    Simply put, I only buy significant dips -- what is affectionately known as "BTFD" (this is a family show so you'll have to figure out that acronym yourself). Even as a long-termer, I usually only open a new position when I expect a minimum 10% return within the first 6-9 months (thus, downside protection). Granted, there are years like 2013 without any market corrections, but the discipline to wait for pullbacks and stage in on dips helps overall performance tremendously since it means outsized gains are still possible by only slightly averaging up during smaller dips.

    I think about four broad categories of factors that determine how the price of any stock moves. They are what's happening with: [1] local and world economies ("macro" factors), [2] the market as a whole, [3] the company's sector, and [4] company-specific news and performance. In fact, I think how any stock moves at any given time is always a function of ever-changing combinations of those factors. Again, my strongest opinion is that when to buy is just as important as what to buy.

    My experience has been that the "sweet spot" for when to buy a stock is usually when 2-3 of the above four factors brings a particular stock (or all stocks) down to undervalued territory. The reason I say 2-3 of the factors is the sweet spot is, when only one of the factors is holding a stock back, that's usually only enough to create minor undervaluation. Conversely, when all four factors conspire to bring stocks down, buying before at least one of the factors subsides is usually too early to avoid further downside.

    2. Staging/Averaging Into Positions

    "The best stock to buy is the one you already own."

    ― Peter Lynch

    I never buy a full position at one time and always stage/average into a position in 3-5 separate buys over a period of 3-18 months. The reason is simple -- I'm not smart enough to accurately call the bottom in every stock every time so staging/averaging in reduces the need to do that since the focus remains on the average price, rather than the price of any one buy. In other words, if I buy a third or a fifth of the full position I want and the stock goes down more, I can just buy more and lower my average price. If I wasn't confident that the stock will go up significantly, despite any dips, I wouldn't have bought the stock in the first place. If the stock takes off after my first buy, I decide whether there's reason to chase it and average up more than I planned to, or if I should wait for a pullback. When a stock goes on an long and strong run while I only have a small portion of the position I want, that's what I call a high-quality problem. Since I don't believe anyone can invest without mistakes or problems, my goal is to limit myself to high-quality problems.

    Now, back to the mechanics of how I actually stage into positions. Both my number of buys and the time period over which I make them depend on my conviction level, and both factors are fluid. For example, with stocks I expect to appreciate substantially in the short term and that I'm 110% certain I want to own for the long term, I might stage in with 3 buys over a course of 3-6 months (sometimes even less). Examples of stocks that were in that category for me at one point are HAL, HCI, KR & TRN. On the other hand, with stocks I expect to move more slowly or that I'm not yet certain I want to own for the long term, I might stage in with 5 buys over a 9-18 month period. Examples of stocks that were in that category for me at one point are GE, EEP, OHI & VLO. One of the advantages to wider scale timing is that it allows me to get out of a position with minimal losses, if the idea goes south or I change my mind.

    I should mention that GE is a unique case since I have a long and happy history with GE stock. Maybe I'll write about that some day, but for now, the point is that GE was only back in my slow-buy category because I already had my full position, but decided to increase the size of it as my conviction level increased and the time frame in which I expected price appreciation decreased. In fact, that's a good example of the last point I want to make on this subject. While I always have a position size in mind before I make my first buy to open a new position, I often decide to make a position larger than I originally intended when I made the first buy, depending on company developments, stock performance, portfolio balancing, etc. Specifically how I go about that is actually the next topic, although not its primary purpose.

    3. Position Trading

    "The best stock to buy is the one you already own."

    ― Peter Lynch

    Oh! Had I mentioned that quote already? Good ... it's worth repeating.

    The primary reasons I trade around core long-term positions are to increase the short-term profits from the positions and reduce risk to principal. I do that by adding relatively small lots to existing positions on dips and selling those lots into subsequent rallies. I think of this as a fluid tactic because I can change the outcome midstream by simply holding the added shares and increasing the size of the core position.

    While "position trading" can increase profits and can actually be a useful risk-management tool, it can also increase risk in some instances. As is typical of the investment risk/return proposition, increased return potential is generally accompanied by increased risk. Although I have never had this happen to me, it is obviously possible to add shares to a position as it is heading into an extended downtrend from which it does not recover within a reasonable time. That is a remote possibility if one owns good stocks, but it is indeed one of the reasons I only position trade once I already have substantial gains in a holding. For example, when I have holdings with >50% gains and add shares on a dip with the intent of selling them back into a rally, and the rally takes longer than I want to wait; I might temporarily give up 5% of my unrealized core position gains, but I still haven't actually lost anything -- I just have more shares with a 45% gain instead of 50%.

    Extremely important to consider with any type of short-term trading are the IRS "wash rule" regarding short-term losses and the tax impact of short-term capital gains. My approach to those issues is that I only position trade when I'm confident not only that I'll make profits, but also that I'm trading enough to make the resulting capital gains worthwhile. Although that works for me, I strongly recommend that inexperienced investors not attempt position trading and that experienced investors consult with their tax accountant.

    4. Using Volatility

    "Never think that lack of variability is stability. Don't confuse lack of volatility with stability, ever."

    ― Nassim Nicholas Taleb

    This topic is actually an extension of the previous one since "position trading" is really only effective with stocks that are relatively volatile (at least in the context I'm using the term). However, I've separated out volatility because trading isn't appropriate for everyone, but everyone should identify volatile stocks in their portfolio and make conscious decisions about them. The main point here is that owning a relatively volatile stock isn't necessarily a bad thing, as long as one recognizes the volatility, identifies its source and makes a conscious decision whether you have the stomach for it. If the stock is volatile because it's a full-on "battleground stock" -- one that's a constant battle between shorts and longs or "activist investors" and everyone else ("activists" used to be called "corporate raiders" in a less politically correct world, so that should be a hint) -- consider getting out unless you're trying to lose money.

    However, if one can identify the source of the volatility, position trading can be useful even for a long-term investor. In fact, I intentionally hold several stocks at all times that are relatively and predictably volatile. Examples in that category are HCI and MTW, though MTW tends to react more to general market weakness, while HCI is more predictable. The reason for that is the business HCI is in, or more accurately, perceptions of that business. In other words, since HCI is in the Florida property insurance business, the stock trades with the weather ... literally.

    For example, it's very predictable that HCI will sell off 10-20% whenever a tropical storm gets close to Florida. It's also predictable that it will regain that 10-20% within a few weeks after the threat passes. As a long-time Florida resident, I pay close attention to Gulf storms so my chances of getting caught off guard are much lower than someone who lives in, say, Idaho. Similarly, from many years of direct experience with hurricanes, I'm probably better at judging the likely outcome than most Idahoans. So, whenever a storm approaches Florida and HCI sells off, I buy extra shares, then sell those shares into the rebound a week or two later. Rinse and repeat for an extra 10-20% a few times a year. Again, this tactic is safest once there are already substantial gains in a position -- my core HCI holdings are up over 200% so I'm very well protected.

    I've referenced many stocks throughout this series of Instablogs in order to help me make my points more clearly by using actual examples. I own or have owned all of them and plan to write articles about most of them.

    Thanks for reading and please leave comments on the above topics since that's part of the reason I've posted this -- in case those smarter than me are generous enough to explain why I might be thinking about any of these topics in a less than ideal way.

    Here are parts 1 and 3 of these ramblings.

    Disclosure: The author is long GE, HAL, HCI, KR, MTW, OHI, TRN, VLO.

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Comments (10)
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  • phemale60
    , contributor
    Comments (2800) | Send Message
    Hi, I just printed your Instablog to read on the subway tonight. I'm sure it's informative and I will learn valuable lessons!! Will print the others also! Keep up the good work.
    1 Oct 2013, 01:50 PM Reply Like
  • DAG1996
    , contributor
    Comments (3081) | Send Message
    Author’s reply » Hi! Thank you very much. These first few Instablogs are somewhat directed at beginners, but I've found that many experienced investors could benefit from some of these concepts as well, which is I why I decided to post them. I look forward to any feedback you might have.


    By the way, I just posed my second article (ACET), but SA selected it for "SA Pro" so it won't be available to people who don't subscribe to SA Pro for I think another 24 hours or something, and I think for only 30 days thereafter.


    I have a third article on the way (CECE) and am still trying to decide among a bunch of picks which one to write about after that.


    Thanks again.
    1 Oct 2013, 02:04 PM Reply Like
    , contributor
    Comments (137) | Send Message
    nice article
    i found some down to earth points that are worth incorporating into what i do .
    i am retired and i focus on dividends ,
    my believe is that the buying price point is critical
    and i will average down if i believe it is a good move on the specific stock
    i also use dips and options to lower the average cost of the shares .
    my target is to hold stocks at a price that is 66% of the high of the previous 52 weeks
    9 Oct 2013, 02:12 PM Reply Like
  • DAG1996
    , contributor
    Comments (3081) | Send Message
    Author’s reply » @JIMSK, Thank you very much for reading and taking the time to comment ... it really means a lot to me to know that you find my ramblings useful, as that's what makes writing them worthwhile.


    I try to keep the Instablogs more down to earth since I have to get much more technical and specific in articles in order for them to pass editorial review (understandably since SA serves many pros too).


    I couldn't agree more that buy price points are critical ... even more so as time goes on since our investment risk tolerance gradually declines, as the time horizon also shortens for when we'll need to rely on our investments for income.


    Thanks again and I hope you'll stop by again in the future.
    9 Oct 2013, 02:25 PM Reply Like
    , contributor
    Comments (137) | Send Message
    i remember talking with a very sucessful realestate person that bought and sold houses for a living .. and i will never forget him telling me that you make your money on the buying price ,, not on the selling price ,, i have carried this advice to my entery into buying and selling stocks ..
    i could be wrong ..
    10 Oct 2013, 12:57 PM Reply Like
  • DAG1996
    , contributor
    Comments (3081) | Send Message
    Author’s reply » Thanks for sharing that. I think it's spot on. Best regards.
    10 Oct 2013, 02:39 PM Reply Like
  • happyshorter
    , contributor
    Comments (915) | Send Message
    I read this very late, because I did not know you before.
    This article is very interesting.
    You could think everything has been written on the subjects of your 3 points, but you give them a special light.
    I will meditate on this, I think this will help me.


    Thank you.
    15 Feb, 12:18 PM Reply Like
  • DAG1996
    , contributor
    Comments (3081) | Send Message
    Author’s reply » @happyshorter, I'm glad you found this helpful. Perhaps parts one and two of the series will be of some benefit as well. Thank you for reading.
    15 Feb, 12:44 PM Reply Like
  • kevinconway
    , contributor
    Comments (1869) | Send Message
    <P class=double> </... also look for companies that are poorly managed and are about to undergo change. Often a stronger leader at the top makes a big difference as well as the full management team. At first is seems like a big problem with all the restructuring costs but then...the magic starts.
    <P class=double> </... stocks...those that bounce up and down on media reports....I try to get on the PR lists for the companies I own so I get the info at the same time as the media...and the media often gets it wrong. One stock jumped 125% in one day....a couple of years later it dropped 70% in a both instances the media missunderstood the news....and most of the people who hold are nuts...except me of course!
    15 Feb, 04:27 PM Reply Like
  • DAG1996
    , contributor
    Comments (3081) | Send Message
    Author’s reply » lol Of course! I agree leadership is key and it's important to get the PR notices directly from the companies. I'm in the middle of writing an article right now about one that media reported earnings completely wrong and sent the stocks down 10-15% in one day.
    15 Feb, 05:19 PM Reply Like
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