Anatomy of a Trade: How to Manage Your Bets

Last March, with the Dow below 7000, I noted semiconductor stocks as unusual market leaders. I’ve been observing their strength and have kept tabs on the group’s prominent stocks.

My interest wasn’t based on elaborate economic analysis or Larry Summers’ plan for stimulating growth, but by rational, objective observation of the securities themselves. You can discuss fundamentals forever, but what ultimately matters is the price (and, to a lesser degree, what people think about the price). The price is what we trade, and the price is what we should primarily follow.

After continuing to watch the sector march higher, I took a position in, and profiled, Advantest (ATE), the world’s dominant supplier of semiconductor chip testing equipment.

Don’t Cash in These Chips

Advantest (ATE) – YTD

Like many stocks, Advantest has rallied. And regardless of whether it was the continued outperformance in semiconductors, the general strength in equities, or just my charming personality, I’ve got a winning trade. And if making money is your goal, having, and holding a winning trade, is exactly where you want to be.

The old saying might be to always go with your gut, but unfortunately, for most people, the first impulse is to grab the cash and sell the moment a profit appears. It’s a tempting thought. After all, I’ve personally made money in the stock. I could unquestionably buy a new gorgeous flat-panel TV screen, some fancy new clothes or go out for a few swanky meals. That impulse is completely understandable, but, more often than not, completely wrong. While it’s true that “you never go broke taking a profit,” you will never actually make a meaningful profit if you’re always snatching gains the first moment they develop.

So while I’ve got no unique insight as to the next move for Advantest, my preference, and for now my strategy, is to let the winner run. Semiconductors were strong as an asset class when I first took notice in March, and that leadership has only become more prominent in recent weeks.

What specifically attracted me to Advantest was the distinct lack of participation and interest from the investment herd, which, despite an impressive gain, still has yet to materialize. There have only been six message board postings on Yahoo Finance this year, and virtually no mentions on Twitter or other social networks. The company gets little attention from domestic analysts, and while I’ve since recommended the stock on Fox News Channel, it’s received scant coverage from the financial press, despite encouraging fundamentals. Just this past week Nikkei English News reported the company’s chip-gear orders may have doubled over the previous quarter.

Most importantly, my position size remains prudent, less than 5% of my total portfolio, with that percentage growing as it should—via share price appreciation. The thesis, and the asset class itself, it far from an all-or-none bet.

The anatomy of a trade consists of observing the markets, positioning yourself to participate in a dominant theme over time, and doing so using sound trading technique, namely position size and risk control, to minimize your losses when you’re wrong and maximize your gains when you’re right. As investors, that’s what we do—that’s all we can do. Everything else is in the market’s hands.

As stocks hit yearly highs on Friday, fear, as measured by the exchange-traded-notes tracking VIX futures, hit fresh lows. iPath S&P 500 VIX Short-Term Futures ETN (VXX), profiled in this space in January, has dropped some 46% since March as investors have again warmed to risk. Interestingly, the VIX remains firmly above its long-term average range, meaning while fears have subsided, they’re still high relative to historical norms.

Stocks Up, Fear Down

iPath S&P 500 VIX Short-Term Futures ETN (VXX) – 6 months

At the time of writing, Hoenig's Fund held shares of Adventest (ATE).