Journeys of a Bumbling Investor

Just read a Motley Fool article titled: 4 Critical Errors You Must Avoid
http://www.fool.com/news/commentary/2005/commentary05122308.htm
which reminded me of another Fool article titled: How to Double Your Money

The lesson is the same. Basically, do not buy a company _just_ purely based on a peceived macroeconomic trend (aka hype). E.g. Nanotech is the next big thing, biotech is the next big thing, baby boomers are going to need lots of healthcare, etc.

What is more important, is the company-specific factors themselves, e.g. how competitive is the company, does it enjoy a monopoly? is its management good? etc.

The macro trend provides the "tailwind" that can push a stock further, provided the company is already speeding in the first place.

I have the faint impression that I read somewhere in one of Buffett’s writings, that a gauge of the rate of growth of a company’s earnings can be estimated by

Expected GDP growth + Expected inflation

Hence say Expected GDP growth = 5%, Expected inflation = 3%. Then a company should be able to grow earnings at around 8%. If its EPS growth is > 8%, then that’s excellent. If its < 8%, then that’s bad.

Since my capital currently is very limited (no spare cash sitting around like a $40bn cash hoard =), everytime I want to enter into a new position, I typically have to sacrifice an existing one.

The usual question that pops up is — at what price should I liquidate my existing position? I realise that I typically have been unable to make that sell decision and precious time and opportunities slip by without any action.

I think there are two main decisions

1. Do you want to switch? That decision should be made based on comparison between the expected rates of return for each alternative, using a long-term price target for each.
2. Should I sell NOW? That decision should be made based on comparison between the immediate-term (intra-day) expected rates of return for each option. For example, say from the start of trading day until now, the stock has been fluctuating up and down between 10.00 – 10.50. The price right now is 10.00, hence the short-term potential gain is say 5%. For the alternative, a judgement call has to be made on the possible immediate gain that can potentially happen. If that is more than 5% (with appropriate probability), then you should sell NOW. If that is less than 5% then you can possibly wait for the existing position to go up from 10.00.

Of course, there is the possibility that the existing position might break lower. In that case, a sale of the existing position should not happen, since the short-term potential gain has increased even more.

Read: http://www.fool.com/news/commentary/2005/commentary05120908.htm

Summary:

1. Large, high-quality stocks can double in 5 years.
2. High-quality stocks can double in 3 years if their industries are in favor.
3. One-year doubles are crazy. Can happen if there is exceptionally strong growth, and a recognition of that growth from the market at large.

Takeaways:

1. Need to look for one-year doubles.
2. Cannot stick with one stock for a year, need to switch between multiple stocks in a year, catching a decent gain in each stock, so that eventually by one year, a doubling is effectively achieved.

Doing intra-day dollar-cost averaging is bad.

When stocks tank, they usually tank for a few days. Hence the same tactic for spotting intra-day lows should be applied to a more "macro" picture of using days. Doing that over "days" allows time for the good/bad news to be widely reported, caught on by other investors, acted upon by everyone. Perhaps a rough estimate of 4 days is necessary for a stock price to fully adjust for a piece of news.

This note follows some thoughts arising from the events that was reported in Trading Note #4.

So far, all my stock buys have some basis of fundamental analysis attached. As I have not yet cultivated the long-term buy-and-hold strategy, I am still interested in benefitting from intra-day price movements.

If I would like to go long on a stock, what I'm thinking is this: Buy in with say 1/2 of your allocated capital first. If the stock price goes up (intraday), sell off the stake that you initially bought. If the stock price goes down, buy in with the rest of your capital (1/2) at the lower price.

Similarly, if I would like to go short on a stock: Sell off 1/2 of your holdings first. If the stock price goes up, sell of the rest of your holdings. If the stock price goes down, you could potentially buy-in depending on the drop.

Does this strategy work?

Not quite. In the case of going long, selling off a stock once it goes up is like selling off your winners instead of letting them run. You should only do that if you are _sure_ that the stock is fluctuating within a fixed trading range. Hence you shouldn't sell when it goes up, meaning that the entry price for the other 1/2 is going to be higher (if the entry takes place at all).

In the case of going short, if the stock price does not drop to a sufficiently low level, then the selling point for the other 1/2 of the holdings will be lower (if the selling takes place at all).

Hm, doesn't seem like you can have your cake and eat it too =)

The past 2 weeks have really been painful, instructive, and thankfully quick.

The short story:
Bought in when it just started plunging, sold it when it bottomed. And later during the day that I sold, the stock shot back up and over my original purchase price =(. Things can't get worse much than that =)

The long story:
The stock has been pretty stable around $10.00 – $10.25 for bout a week. Then one day, a neutral piece of news (what I peceived to be) came out. The next trading day, the stock shot up to bout $10.40 for pretty much the rest of the day.

Mistake #1: Thinking that the stock will be stablising at a higher trading range, I wanted to go long the next day at the low-end of the intraday fluctuations.

So the following that I bought in at $10.28, at the same time making Mistake #2: Not buying in at the intraday low (see Trading Note #3). Mistake #1 was a logical/strategic mistake, and Mistake #2 was an execution mistake.

What happened for 4 consecutive trading days after that was that the stock tanked, with the trading range steadily dropping till $9.93 – $10.00. During that 4 days, I was trying everyday to liquidate my holdings and cut my losses, but the greed of earning a few points and minimising my losses prevented the sale every day.

Mistake #3: Being too freakin greedy! And not having decided on a "minimum acceptable selling point" before the market opens.

Finally, when it got down to $9.93, my over-riding thought was "I NEED to get rid of my holdings NOW, regardless of price!". The loss was becoming too significant with potential for even greater loss. Hence I sold all my stake at $9.97.

Mistake #4: Selling without thinking! (see analysis below)

Following my sale, as though Mr Market knew that it had finally got me =), the price just steadily climbed to $10.46, completing the manoeuvre by twisting the blade that was stuck in me for the past 4 days.

Learning Points:

I think there are 3 stages of "development":

1. The first is when you keeping hanging on to your losers, not wanting to realise the loss, hoping for the stock to recover and tying up that sum of money which could be generating better returns elsewhere.
2. The second is when you cut your losses promptly, perhaps with a threshold (e.g. 2% maximum loss).
3. The third is when you combine that with a fundamental view of the stock. If you assume that you currently _do not_ hold any stock of that company, would you want to buy it at that particular price? If the answer is yes, then you should hang on.

I initially thought that I understood point 3. But it turned out that holding a plunging stock clouded my judgement and resulted in a strong urge to just "end the losses". Hence the importance of making that judgement call with the assumption that you do not have any position.

Key takeaways:

1. When an intra-day bottom has hit, it should be _OBVIOUS_ that that _IS_ the intra-day bottom (i.e. prolonged plunge to the 'low' level)
2. High/lows due to spikes up/down in the first 1 hour of the market opening, should be ignored.

Just missed a short-term rally yesterday.

Points learnt:
When deciding at what price to enter into a position, consider:

1. Is the stock price very volatile?
2. Will the recent good news cause the stock price to jump to a higher and stable level?

If the answer to both questions is yes, then you have to be willing to enter into a position at a higher price — don't be greedy. Warren Buffett has an analogy of swinging his bat _only_ when the odds are clearly profitable. I would say that that happens in the case when you can afford to "not buy". But sometimes, the potential gain (ie. opportunity cost) of having a position is large enough for you to swing slightly off just to catch the ball, else the game might just finish without you.

In summary — don't be greedy. If you really want to be long a position, be prepared to give a little. You don't really have to catch the highest high to sell, and the lowest low to buy.