Institutional investors run most of the money in the market. Most of them have been trained to think in valuation terms exclusively, and so they set buy and sell prices for their positions. This influences even small investors, because of the impact of sell-side research. Almost every buy or sell recommendation comes with a price target. The sell side analysts often issue new buy or sell when a price target they have been looking for occurs.
But not every fundamental investor agrees on what the proper prices are for buying and selling. As the old saying goes, “It takes two to make a market.” Sometimes, I will make it into the office and my trader will tell me that someone is aggressively selling a company that we own. I might ask him if our brokers have any feel for the size of the seller, and how desperate he is. The answer is usually “no,” but if we do get an answer, that can help dictate our trading strategy. We would want to buy more as the big seller is closer to being done. In fact, we want to buy his last block of shares from him, if possible. Sometimes that can be arranged by talking to our broker; other times not.
As another aside, this is simpler to do in the bond market than the stock market. The large brokers generally know who is doing what. Be nice to your sales coverages, and you’d be amazed what they will tell you…. Here’s a stylized example.
Broker: “You sure you want to buy that Washington Mutual bond?”
Me: “Yes, why?”
Broker: “Uh, there’s someone with size selling the name.”
Me: “How much size?”
Broker: “Best indications are eight times your order size.”
Me: “I can’t take that much down. Keep me in mind, and when he gets down to about double the size of my order, call me, and I’ll take the tail [everything that’s left].”
Broker: “You got it.”
But suppose we don’t have any idea what the intentions of the seller are. We would have to be more humble, and try to infer from the chart what his methods are. Does he put a ceiling over the stock price, and only sell when it gets to a certain level? Or is he a “mad bomber” that keeps selling regardless of the price level? Looking down the holders list, can I figure out anyone who might be incented to sell so much, and so aggressively? Who is disappointed at present that has a trading style like the group that is selling the stock?
Does he sell in dribs and drabs, scaling over time? Does he do a series of block trades? Is he using some sort of quantitative selling strategy that incorporates both time and price? These are the questions that I try to answer as I strategize my trading. It doesn’t give me perfect information, but it aids me at the margins.
So, say after your analysis of the technicals, you think the stock will continue to go down for a while, or won’t rise because the seller is big, seemingly larger than you can take down. Still, you like the company at the present valuation levels. What do you do?
You could sit on your hands, and wait out the seller. But what if you’re wrong about the size of the seller? The stock could move higher before you get a position on if the seller is smaller than you anticipated. Remember, other traders are watching the big seller also, and they will be waiting for him to be done as well.
You also could buy your full position immediately. After all, you have firm convictions about the secular trends and the stock’s valuation. Timing is for losers, and we are fundamental investors. Well, okay, but what if you are wrong, and the seller is right? Or, what if you like the idea here for the long run, but you would buy even more at lower prices? As Bill Miller has put it, “Lowest average cost wins.”
Again, we could put on half the position and wait for the seller to be done. I like that, but are there alternatives? We could estimate the size of the seller (imperfectly), try to figure out how long he will be around and do a time-based scale where we put on 80-90% of a full position over that estimated time period. We also could do a price-based scale, and try to estimate (even more imperfectly) how much the seller will drive down the price before he is done. Buy 25% of a full position now, and then scale the remainder of what would be 80-90% of a full position down at the price you the seller gets exhausted at.
These strategies are illustrative, and meant to show the range of ways that one can balance off fundamental conviction versus the technicals of the market. In general, price scales work better when you think the seller is valuation sensitive, or other buyers are showing up in size to gobble up the seller’s supply at a given level. In the absence of that, time-based scales are the proper strategy if you have some confidence in the timing of the seller. Failing all of that, my humble strategy is to buy half and wait. It will never be perfect, but if I am right on the fundamentals, the results will be good enough.