Scaling In and Out of Positions
I don't like change and that's getting worse. However, I know that to survive one has to adapt. It's time to start accumulating positions in good companies.
Lately I've been scaling in and out of spread betting positions , and that's the plan for the foreseeable future. I suppose I tested it last summer on the banks and it went very well. I've also used this strategy successfully to trade Telecom Plus [LON: TEP].
The theory is that one simply cannot time a bottom so why try. When you think a bottom might be close you start to build a position. Here's an example.
Share A is priced £1, having fallen from £2. You think it is worth more.
We invested £2,700. We have banked £1,900 and still have 1,000 shares worth £1,000.
- You buy 1,000 shares at £1.
- The share falls to 90p, you buy a further 1,000
- You now hold 2,000 shares and have spent £1,900
- The shares falls to 80p, you buy a further 1,000 shares
- You now hold 3000 shares and have spent £2,700
- The share price rises back to 90p
- You sell 1,000 shares and bank £900
- You still hold 2000
- The price rises to £1
- You sell another 1,000 shares and bank £1,000
The price is back where we started but we are in profit.
Costs have been ignored.
The skill is getting the scale right.
Yes, this cuts profits and runs losses and so is dangerous. It can only be 'played' on shares that you are confident will at some point go up.
Note that this is not averaging down. Averaging down is buying on the way down with the intention of holding the lot for the ride back up. This is scaling in and scaling out so at the end one always ends up with the number of shares first bought.
This strategy is akin to what a value investor would do when buying into a position. They'd look at the net asset value of the company and only be buying when the market capitalisation drops into 2/3rds of that range. As the price drops further so the investment increases.
So if I buy 5000 Share A tomorrow and there's a 'problem' then I get hit; if I buy in 1000 lots and get caught with a problem at the end then I will get hit by a lot less than had I bought 5000 in one go. If I get hit at the start then I am solidly better off.
If you scale in every 10%, you can only ever made 10 trades before the share hits zero, 20% is 5 trades etc... The catch with this is that you need to be relatively sure that you understand liabilities, that fraud isn't taking place and that you don't fall in love with a company or its shares when doing this.
Of course if you think a share might go to zero you probably wouldn't be buying it in the first place.
The danger with scaling is that it could quite easily escalate towards a point where you carry on buying as the price falls further in the personal belief the market is wrong and you are right. So realistically the plan caps itself with 2-3, maybe 4-5 in this market, trades at 10%. The important thing is that the total holding is less than say 5% of your portfolio, and you stop using the strategy when your scaled buying approaches that.
I have managed to garner a profit out of LLOY, BARC, TEP, SBRY & HLO with this method and haven't been caught yet. Indeed TEP is still below where I first bought it but I am well in profit. The words first, always, and time, come to mind but overall I have sufficient faith in my ability to pick shares not to get caught very often. Words, last and famous also come to mind.
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'Scaling In and Out of Positions' edited by DB, updated 15-Mar-09
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