Buying: Leave Room to Average Down

The single most crucial factor in trading is developing the appropriate reaction to price fluctuations.

Investors must learn to resist 

• fear, the tendency to panic when prices are falling, and 
• greed, the tendency to become overly enthusiastic when prices are rising. 

One half of trading involves learning how to buy. 

• In my view, investors should usually refrain from purchasing a "full position" (the maximum dollar commitment they intend to make) in a given security all at once. Those who fail to heed this advice may be compelled to watch a subsequent price decline helplessly, with no buying power in reserve. 
• Buying a partial position leaves reserves that permit investors to "average down," lowering their average cost per share, if prices decline. 

Evaluating your own willingness to average down can help you distinguish prospective investments from speculations. 

• If the security you are considering is truly a good investment, not a speculation, you would certainly want to own more at lower prices. 
• If, prior to purchase, you realize that you are unwilling to average down, then you probably should not make the purchase in the first place. 

Potential investments in companies that are

• poorly managed, 
• highly leveraged, 
• in unattractive businesses, or 
• beyond understanding 

may be identified and rejected.

Buying: Leave Room to Average Down

The single most crucial factor in trading is developing the appropriate reaction to price fluctuations.  Investors must learn to resist:

• fear, the tendency to panic when prices are falling, and 
• greed, the tendency to become overly enthusiastic when prices are rising.  

One half of trading involves learning how to buy.

• In my view, investors should usually refrain from purchasing a "full position" (the maximum dollar commitment they intend to make) in a given security all at once.  
• Those who fail to heed this advice may be compelled to watch a subsequent price decline helplessly, with no buying power in reserve.  
• Buying a partial position leaves reserves that permit investors to "average down," lowering their average cost per share, if prices decline.  

Evaluating your own willingness to average down can help you distinguish prospective investments from speculations.  

• If the security you are considering is truly a good investment, not a speculation, you would certainly want to own more at lower prices.  
• If, prior to purchase, you realize that you are unwilling to average down, then you probably should not make the purchase in the first place.  
• Potential investments in companies that are poorly managed, highly leveraged, in unattractive businesses, or beyond understanding may be identified and rejected.

How to make money in a down market?

Here is an example of making money in a down market.

At the end of 2007, an investor was enthusiastic about a stock ABC.  Then the severe bear market of 2008/2009 intervened.  Here were the investor's transactions in stock ABC.

1.11.2007  Bought 1000 units  @  $6.00          Purchase value  $6,000
6.11.2007  Bought 1000 units  @ $ 6.75          Purchase value  $6,750
15.9.2009  Bought rights 800 units @ $ 2.80    Purchase value  $2,240
!5.9.2009   Bought 5,500 units  @ $ 3.51         Purchase value  19.305

Total bought 8,300 units
Purchase value  $34,295
Average price per unit $ 4.13

Current price per unit  $ 5.51
Current value of these 8,300 units is $ 45.733.

This is a total gain of $ 11,438 or total positive return of 33.4% on the invested capital, excluding dividends, received for the investing period..


Lessons:
1.  Investing is most profitable when it is business like.
2.  Stick to companies of the highest quality and management that you can trust..
3.  Stay within your circle of competence.
4.  Invest for the long term.
5.  Generally, hope to profit from the rise in the share price.
5.  At times, the share price becomes cheap for various reasons # - be brave to dollar cost average down, provided no permanent deterioration in the fundamentals of the company..


# Severe bear market of 2008/2009.

Sell Urgently when the Fundamentals Deteriorated

Averaging Down

Buying more shares of a stock you already own, and getting the new shares at a lower price because the stock has been dropping. 

Averaging Down is not advisable in this situation.

Remember:
Transmile, Nam Fatt, Kenmark, Carotec

The buy-and-hold strategy

The buy-and-hold strategy

Jonathan Chevreau, Financial Post Published: Friday, April 17, 2009

Among the many casualties of the great bear market of 2008-09 may be the buy-and-hold strategy or the Warren Buffett approach of buying good businesses and waiting patiently for the market's perception of their value to catch up.

Indeed, when it seemed the market had hit new lows last November, CNBC aired a feature declaring the "death of buy-and-hold," with pundits claiming only suckers hung on through thick and thin. And value-oriented fund company AIC Limited, which still uses the slogan "buy, hold and prosper," has suffered from such derogatory variants as "buy, hold and perspire" or "buy and fold."

But rumours of the death of buy-and-hold may be premature.

The Investment Reporter, a well-regarded newsletter founded in 1941, recently concluded buy-and-hold portfolios do better over the long and short run, citing an academic study (by Lakonishok, Schleifer and Vishny) that looked at returns of actively managed pension funds over six years. It found that, on average, buy-and-hold portfolios beat actively managed portfolios by 0.78% a year, not factoring in taxes, management fees or high cash positions.

A buy-and-hold approach

• minimizes commissions and tax events and, naturally, 
• lowers the chances of mistiming the market. 

It's compatible with passive indexing strategies, but you don't have to be an indexer to benefit from this approach. It can be used equally with quality dividend-paying stocks, ladders of bonds or GICs.
Dan Richards, president of Strategic Imperatives, says investors have swung from buy-and-hold to frequent trading but either extreme is a "prescription for disaster." He says academic research from Terrence Odean and Brad Barber shows frequent trading hurts investment returns. The two American business professors wrote a seminal article in 1999 called Online Investors: Do the slow die first?

Vancouver financial advisor Clay Gillespie believes buy-and-hold works for various forms of managed money, such as mutual funds, wrap accounts and other fee-based investment management solutions, although it may not always work with stocks. "An individual company may go out of business and thus have a return of zero." With a particular stock, it may be necessary to sell when

• there are changes in one's personal situation, retirement, for example, and
• it's advisable to reduce volatility. 
• Portfolio rebalancing may also require some tweaks in the buy-and-hold approach. 

But "style drift" usually tends to produce poor performance over time, he says.
Mutual fund companies encourage buy-and-hold, often levying short-term trading penalties on those who trade in and out too often. Typically, fund unitholders buy high and sell low when they switch too often. "It is this multi-percentage point drag that buy-and-hold investors are trying to avoid," says Norm Rothery, chief investment strategist for Dan Hallett & Associates.

Joe Canavan, chairman of Assante Wealth Management, believes fund investors can successfully build portfolios that include both fund managers who use a buy-and-hold approach as well as managers who use a frequent-trading approach. The danger is in trying to do only one or the other, then changing your horses midstream.

That is more likely to result in being "whipsawed," Mr. Canavan says, incurring losses with one strategy, then abandoning that for the opposite approach just as the tide was about to turn.

In his Canadian Capitalist blog, Ottawa-based Ram Balakrishnan advises to "keep faith in buy-and-hold." He reassures readers it's "hard to maintain equanimity in the face of such a steep decline as right now. But what other strategy is there other than buy-and-hold, where almost everyone can have a good shot at reasonable returns? I don't think there is one."

Unlike most advisors, Robert Cable, Toronto-based head of ScotiaMcLeod's Cable Group, is a strong believer in "seasonal" market timing, also called a "sell in May and go away" strategy. While investors may want to emulate Warren Buffett and buy and hold forever, in practice "nobody does it," he says. He recalls asking 300 advisors at a Florida conference how many of their clients had bought and held the same portfolio a decade or more. The only hand that went up represented a client who was literally in a coma following an accident and whose account could not be traded.

"Anyone who goes into investing with the intent of buying and holding virtually always succumbs to outside pressures to abandon the strategy. My guess is when we have nobody believing in buy-and-hold again, we will again be ready for one big bull market to take off," says Mr. Cable.

Markham-based advisor Robert Smith says buy-and-hold works, but not in isolation. Investors need

• proper asset allocation geared to their risk tolerance, 
• portfolios must be well-diversified and 
• investments can't have been purchased at bubble-like prices. 
• They also need to buy during the tough times to bring down their average costs, he says.

"If the investor follows all these requirements, buy-and-hold will not fail them," Mr. Smith says.

Read more: http://www.financialpost.com/story.html?id=1507182#ixzz0eYEmvC9K
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Comment:  My personal experience of 20 years, buy and hold is safe for selected stocks. 

You need a 100% gain to erase a 50% loss; averaging down will help you recover faster

You need a 100% gain to erase a 50% loss

Averaging down will help you recover faster

Jonathan Chevreau, Financial Post Published: Wednesday, September 16, 2009

After recoveries of 45% or more in major stock markets since the Crash of 2008, investors may well wonder how it is they're still not back to even.

Getty Images 

After recoveries of 45% or more in major stock markets since the Crash of 2008, investors may well wonder how it is they're still not back to even.

After recoveries of 45% or more in major stock markets since the Crash of 2008, investors may well wonder how it is they're still not back to even.

There are two reasons.

• One, broad markets are still below the highs reached before the crash. 
• Two, the arithmetic of loss means a 50% loss followed by a 50% rise does not mean you're back to even.

In the current edition of Graham Value Stocks, Norman Rothery notes the bellwether S&P500 index fell 57.7% peak to trough in the bear market, not counting dividends. It has since surged 53.1% from its lows but it still must rise another 54.4% to regain that former high. Thus, it would have to move 136.4% from the bottom reached after the original 57.7% loss, a result Rothery concedes may shock those unfamiliar with "the tyranny of losses."

The math is more understandable in absolute dollars. If you invest $100 at a top and lose 57.7%, you have just $42.30 at the bottom. But any gains you enjoy subsequently are coming off a lower base. Thus, even a 100% gain of $42.30 brings you only up to $84.60 -- still $15.40 less than the $100 you started with. To get back to $100, you'd need a 136.4% gain.

This is the ruthless arithmetic that has investors 100% in stocks -- or worse, leveraged so they were more than 100% in stocks -- licking their wounds in bear markets. However, B.C.-based financial planner Fred Kirby says ruthless arithmetic can be made to work to investors' benefit if dividends are reinvested during declines. This dramatically cuts the number of years needed to recover from losses.

Opportunistic buying can be combined with rebalancing of portfolios to maintain a normal ratio of stocks to bonds. Thus, after the 1929 crash, investors who reinvested dividends and regularly rebalanced recovered in seven years, compared to 22 years for all-stock investors who did not adopt this dual strategy.

Vancouver-based financial planner and author Diane Mc-Curdy says younger investors who dollar-cost averaged into the market early in 2009 have already done very well. Older investors should be conservative and adhere to the rule of thumb that fixed-income exposure should equal their age: so a 40-year old would be 60% stocks to 40% bonds.

The more you had in equities during the crash and the more those equities were in risky segments of the market, the worse the arithmetic of loss. Here, the accompanying chart adapted from Rothery's newsletter is instructive.

In peak-to-trough terms -- with the trough in March 2009 -- the hardest-hit market was the MSCI Emerging Markets index, which fell 67.4%. By early September, it was still 36.8% below its highs, despite the fact emerging markets bounced back 93.8% from their lows. They still must rise a further 58.1% to get back to their former highs. If you're in an emerging markets mutual fund or exchange-traded fund, you're still under water. Of course, if you were prescient enough to buy more at the bottom, you've almost doubled your money on that portion of your bottom-fishing adventure.

A glance at your portfolio may reveal that if you did do what the fund companies urged and "went global" some years back, you're probably still hurting most in funds that track the MSCI EAFE Index: Europe, Australia and the Far East. While the EAFE index didn't fall quite as hard as emerging markets -- it fell a nasty 63.5% -- at this point it still has "the largest hill to climb," Rothery says. EAFE markets are still 39.1% below their peak and have retraced only 66.9%, leaving almost as much again -- 64.2% -- before unitholders feel whole again.

Even the TSX composite still must rise 39.4% to get back to its former highs: something most people realize intuitively since the TSX passed 15,000 before the crash and is now just above 11,000.

Tomorrow, we'll look at what recourses investors may have to recoup losses.

jchevreau@nationalpost.com

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Pyramid Your Way To Profits

Pyramid Your Way To Profits
by Cory Mitchell (Contact Author Biography)


Pyramiding involves adding to profitable positions to take advantage of an instrument that is performing well. It allows for large profits to be made as the position grows. Best of all, it does not have to increase risk if performed properly. In this article, we will look at pyramiding trades in long positions, but the same concepts can be applied to short selling as well.


Misconceptions About Pyramiding

Pyramiding is not "averaging down", which refers to a strategy where a losing position is added to at a price that is lower than the price originally paid, effectively lowering the average entry price of the position. Pyramiding is adding to a position to take full advantage of high-performing assets and thus maximizing returns. Averaging down is a much more dangerous strategy as the asset has already shown weakness, rather than strength. (For further reading, see Averaging Down: Good Idea Or Big Mistake?)Pyramiding is also not that risky - at least not if executed properly. While higher prices will be paid (in the case of a long position) when an asset is showing strength, which will erode profits on original positions if the asset reverses, the amount of profit will be larger relative to only taking one position.

Why It Works

Pyramiding works because a trader will only ever add to positions that are turning a profit and showing signals of continued strength. These signals could be continued as the stock breaks to new highs, or the price fails to retreat to previous lows. Basically, we are taking advantage of trends by adding to our position size with each wave of that trend.

Pyramiding is also beneficial in that risk (in terms of maximum loss) does not have to increase by adding to a profitable existing position. Original and previous additions will all show profit before a new addition is made, which means that any potential losses on newer positions are offset by earlier entries. Also, when a trader starts to implement pyramiding, the issue of taking profits too soon is greatly diminished. Instead of exiting on every sign of a potential reversal, the trader is forced to be more analytical and watch to see whether the reversal is just a pause in momentum or an actual shift in trend. This also gives the trader the foreknowledge that he or she does not have to make only one trade on a given opportunity, but can actually make several trades on a move.

For example, instead of making one trade for a 1,000 shares at one entry, a trader can "feel out the market" by making a first trade of 500 shares and then more trades after as it shows a profit. By pyramiding, the trader may actually end up with a larger position than the 1,000 shares he or she might have traded in one shot, as three or four entries could result in a position of 1,500 shares or more. This is done without increasing the original risk because the first position is smaller and additions are only made if each previous addition is showing a profit. Let us look at an example of how this works, and why it works better than just taking one position and riding it out.

Real-World Application

For simplicity, let's assume we are trading stocks for our first example, and have a $30,000 trading account limit. The maximum we want to risk on one trade is 1-2% of our account. Using a 1% maximum stop, in dollar terms we are only willing to risk $300. A stop will be placed on the trade so that no more than this is lost. We look at the chart of the stock we are trading and pick where a former support level is. Our stop will be just below this. If the current price is 50 cents away from the last support level and we add a small buffer (so, 55 cents), we can take 545 shares ($300/$0.55=545). Round this number down and only take 500 shares; our risk in now less than $300. We could buy our 500 shares and hang on to them, selling them whenever we see fit, or we could buy a smaller position, perhaps 300 shares, and add to it as it shows a profit. If the stock continues to trend, we will end up with a larger position (and thus more profit) than 500 shares, and if the stock falls we only lose money on 300 shares - a loss of only $165 ($0.55*300) as opposed to $275 ($0.55*500) if we only took a static 500 share position.Now, let's take a look at an example using a 15-minute chart of the Great Britain pound against the Japanese yen (GBP/JPY). The circles are entries and the lines are the prices our stop levels move to after each successive wave higher.

Figure 1: November 4, 2008
Source: ForexYard

In this case, we will use a simple strategy of entering on new highs. Our stops will move up to the last swing low after a new entry. If a stop price is hit, all positions are exited. Our entries are 155.50, 156.90, 158.10 and 159.20 as we add to our position with each successive move to new highs after a reversal. The latest reversal low gives us an original stop of 154.15 and then progressively 155.50, 157.00, 157.50. Finally, we have a reversal and the market fails to reach its old highs. As this low gives way to a lower price, we execute our stop at order at 160.20, exiting our entire position at that price. (For more, see Is Pressing The Trade, Just Pressing Your Luck?)

The Verdict

Assume we can buy five lots of the currency pair at the first price and hold it until the exit, or purchase three lots originally and add two lots at each level indicated on the chart. The buy-and-hold strategy results in a gain of 5 x 470 pips, or a total of 2,350 pips. The pyramiding strategy results in a gain of (3 x 470) + (2 x 330) + (2 x 210) + (2 x 100) = 2,690 pips. This is almost a 15% increase in profits, without increasing original risk. This can be further increased by taking a larger original position or increasing the size of the additional positions.

Problems With Pyramiding

Problems can arise from pyramiding in markets that have a tendency to "gap" in price from one day to the next. Gaps can cause stops to be blown very easily, exposing the trader to more risk by continually adding to positions at higher and higher prices. A large gap could mean a very large loss. Another issue is if there are very large price movements between the entries; this can cause the position to become "top heavy," meaning that potential losses on the newest additions could erase all profits (and potentially more) than the preceding entries have made.

Final Notes

It is important to remember that the pyramiding strategy works well in trending markets and will result in greater profits without increasing original risk. In order to prevent increased risk, stops must be continually moved up to recent support levels. Avoid markets that are prone to large gaps in price, and always make sure that additional positions and respective stops ensure you will still make a profit if the market turns. This means being aware of how far apart your entries are and being able to control the associated risk of having paid a much higher price for the new position. (For more on preventing losses, see A Logical Method Of Stop Placement.)

by Cory Mitchell, (Contact Author Biography)Cory Mitchell is an independent trader specializing in short- to medium-term technical strategies. He is the founder of http://www.vantagepointtrading.com/, a website dedicated to free trader education and discussion. After graduating with a business degree, Mitchell has spent the last five years trading multiple markets and educating traders. He has been widely published and is a member of the Canadian Society of Technical Analysts and an affiliate of the Market Technicians Association.

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Averaging Down: Good Idea Or Big Mistake?

The strategy of "averaging down", as the term implies, involves investing additional amounts in a financial instrument or asset if it declines significantly in price after the original investment is made. It's true that this action brings down the average cost of the instrument or asset, but will it lead to great returns or just to a larger share of a losing investment?

Practical Applications

Some of the world's most astute investors, including Warren Buffett, have successfully used the averaging down strategy over the years. While the pockets of the average investor are nowhere near as deep as deep as Buffett's, averaging down can still be a viable strategy, albeit with a few caveats:

Averaging down should be done on a selective basis for specific stocks, rather than as a catch-all strategy for every stock in a portfolio. This strategy is best restricted to high-quality, blue-chip stocks where the risk of corporate bankruptcy is low. Blue chips that satisfy stringent criteria - which include a long-term track record, strong competitive position, very low or no debt, stable business, solid cash flows, and sound management - may be suitable candidates for averaging down.

Before averaging down a position, the company's fundamentals should be thoroughly assessed. The investor should ascertain whether a significant decline in a stock is only a temporary phenomenon, or a symptom of a deeper malaise. At a minimum, factors that need to be assessed are the company's competitive position, long-term earnings outlook, business stability and capital structure.

The strategy may be particularly suited to times when there is an inordinate amount of fear and panic in the markets, because panic liquidation may result in high-quality stocks being available at compelling valuations. For example, some of the biggest technology stocks were trading at bargain-basement levels in the summer of 2002, while U.S. and international bank stocks were on sale in the second half of 2008. The key, of course, is exercising prudent judgment in picking the stocks that are best positioned to survive the shakeout.

http://www.investopedia.com/articles/stocks/08/average-down-dollar-cost-average.asp?partner=NTU

Comment:

In a poker game, when would you put more money onto the table? Putting money on the table may results in a bigger loss or a bigger gain. Averaging down in buying stocks shares similar conotations. However, there are situations as listed above, when averaging down may be a strategy you can employ selectively.