On your positions

This is another area that can mean the difference between winning and losing in the market. When you initiate a position, you do so with a relatively small position relative to how much of it you eventually would like to own. This serves the purpose of limiting losses on a dollar basis in the event you are wrong at the onset of the position. If the stock performs as you expected, you buy more. Once the position is 50% of the desired amount of stock you want, you begin to employ a strategy called pyramiding, meaning you buy additional smaller lots every time the stock acts well, or shows off its relative strength. The definition of acting well could mean many things, and can be quite subjective. All the time though, you are creeping up your stop on the entire position to retain profits on the successful lots and limit losses on the additional, smaller lots purchased.

The only time you should have a position in your account that is large relative to your other holdings is after that stock has performed well again, and again, and again. In essence, that position is now a keeper, and it has earned its place in your portfolio. You are putting more capital into positions that have proved they can make you money.

When exiting a position, you can sell all at once netting a full substantial profit, or you can sell half, or a 3rd of the position, giving a little more flexibility in your account management. Ex: you want to own $100,000 worth of AAPL. So you start out by buying $20-$25K worth with a very tight stop in case you are wrong, limiting your loss somewhere between $500 or $1,000. If the stock advances strongly, increase your position gradually and raise your stop somewhere near breakeven. After that, if it continues to advance, continue to buy lots of decreasing size until you have achieved your desired position. This ensures that after the purchase of the 1st lot, your percentage gain on the entire position is never reduced by more than 50%.

If you have been able to build a full position, this means without a doubt that you were right in your analysis and you can feel confident in holding this position for extended gains as it has proved its worth. Perhaps relax your stop a bit to account for normal corrections, after all, nothing ever goes straight up; but at no point allow the position to erode hard-earned gains away on you, and never let a profitable position turn to a loss. That’s the height of stupidity. Circumstances like this I consider non-existent or negligent account management. You would think, given words like that, that a beaten-down investor would have some kind of recourse in the retail world. But no, they’ve signed away all their rights (save for a dog-and-pony arbitration) in the original account agreement.

RM ~Feb 2011

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