For all the endless banter in print, online and on TV about what to buy or sell, remarkably little attention is ever devoted to when to buy or sell -- or even more importantly -- how to do it.
Stocks don't exist in the abstract, but rather at a particular time and in a particular fashion within our portfolios. So both the "when" and "how" of XYZ often matters even more than XZY itself.
There's no foolproof approach, of course. But for all the analysis and angst, the odds are stacked against most investors from the start simply because they insist on buying stocks out of season namely, when they're breaking down to multi-week or multi-month lows.
Like the weather, the moon or other natural cycle, markets aren't chaotic, but move in trends that tend to persist over time. Just as a garden's growth depends on planting seeds at the right time, investors must insure potential stock purchases are in season before they buy.
In today's market, that would mean avoiding assets like gold stocks, such as Newmont Mining (NEM),
Most crucial (and rarely discussed) is how to allocate once you've decided you want in. Do you buy 100 shares or 10,000? Sell a put option or buy a call?
Knowing that investing is like surgery (the fewer cuts the better), I opt for a KISS ("Keep it Simple, Stupid) approach. If you're bullish on XYZ, buy shares of XYZ. But how?
Human instinct can prompt us to act in exactly the wrong fashion. So when taking an initial position, for example, many investors are apprehensive and choose to start with a relatively insignificant trade, say $500 worth of stock in a portfolio of $100,000 or more. ??
Very often the stock ends up performing as expected, but the investor doesn't fully benefit because of the nearly nonexistent size of the original trade.
Adding insult to injury, it's only after XYZ soars (and the trade is popularized and accepted by the herd) they feel comfortable taking a larger position. Of course, by then the real move has almost always been made.
In reality, your initial purchase should be your biggest one, a standardized trading unit that, as we've written about before, amounts to between 2% and 5% of your overall portfolio.
Using a fixed percentage initial allocation eliminates the subjective guessing game of choosing favorite trades. That market should do that, not us.
The expectation is that the trade will grow over time as the market rises, both as a result of market appreciation and by reinforcing the trade through subsequent purchases. The trade may also be enhanced with the addition of similar correlated assets, such as other companies from the same industry or sector group.
As portfolio managers, our goal over that process should be to keep the average cost as close to the initial purchase as possible. So if I put 3% of assets (let's say 500 shares) into XYZ at $45.25, any additional allocations should be made with a fewer number of shares. At $46.25, I might add an additional 250. At $47, just 50 shares more.
The net effect is to bolster trades with a discipline that weights the trade based on its strength, not our gluttony. Reducing the size of additional purchases as a stock rises ensures our average cost per share remains below the current market price, and as close to the initial purchase as possible.
That creates the profit we all seek.—Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC.