The Great American Investment Creed of “buy low and sell high” sounds so simple, but it must be very hard to do on a consistent basis, or we would all be a lot richer.
To buy a stock like Amazon early on and get rich is the American dream. But it is not very realistic. Sure, it is doable, but very, very hard to actually do in real life.
Amazon (AMZN) was at 10 cents a share (split adjusted price) in the late 1990s. It is now over $183 per share, a 183,000% increase as of July 19, 2024. What’s not to like about returns like that? $10,000 becomes $18.3 million.
Sticking to your investment discipline becomes difficult when share prices drop 95%, as Amazon’s did three times between then and now. How many investors are willing to ride a stock down 95% before throwing in the towel? Not many. Would you?
Assume you had invested $10,000 into Amazon in 1997. Your investment grows to $1,000,000 and you’re feeling great. Then the share price starts to slide. With a gut-punch you see your $1,000,000 account statement reads only $500,000. Next quarter it is $300,000, gulp. A few months later you are down to $100,0000. Rolaids, please. Then $50,000!
That is what a 95% decline looks and feels like. And that type of loss happened to Amazon shares not once, but 3 times since 1997! Would you really hold on to that stock? I wouldn’t.
To quote the late Marian McClellan, creator of the McClellan Oscillator, one of the most widely used stock market indicators, “Some investors invest when they have money and sell when they need money. I prefer to use more sophisticated methods.”
That’s why part of my investing discipline includes position sizing and risk management. Position sizing may be a foreign term to many investors, but trading is not an all-or-nothing endeavor. Using these factors, I don’t have to jump into an investment with 100% of what I plan to invest, or to sell whole positions and hunker down at the first decline, or the first bit of bad news.
Position sizing, how much of an investment to hold, is part art and part science. Knowing what to buy is more art. When to buy and add to your position is more science.
Having been a mutual fund manager a couple of decades ago (yikes!), I learned that most mutual fund managers will confide that they only have 20-30 really good stock picks at any one time. If regulators or fund management wants a diversified fund holding 100, 200 or more stocks, this means that the majority of the fund’s holdings are the manager’s second-best choices. Really good managers, like Warren Buffet, tend to focus on a small number of really good companies. Me, too.
If I want my portfolio to ultimately hold 20 stocks, a promising stock will eventually be 5% of my total portfolio. But I don’t buy the full 5% allocation at one shot. I will initially buy a small amount of the stock. If it disappoints and drops, I’ll sell with only a small loss because I bought only a few shares. If the stock continues to climb, I’ll buy a little more and a little more. After a few of these buys, I’ll have some nice gains built up because I would not have been buying if the price hadn’t continued up. Then if the stock begins to slide, I may be able to sell with the loss only to profits, not my principal. Risk Management 101.
It often takes years of doing this to build a portfolio with full allocations. Investing requires patience.
If the stock price continues up and the gains have moved me past my investment target (5% in this case), I will start to bank some profits by selling enough shares until all I have left riding is profits, not principal. At this point the trade is called a “free trade” because no principal is at risk. Risk Management 201.
By the time a free trade is established, the viability of the investment has proven itself. And unless the outlook for the company changes, I will continue to strategically sell to take profits at high points and buy when opportunity puts the stock “on sale.” Trading 101.
My primary job as a professional investment manager is to manage the risk associated with investing and position sizing is a big part of that. There will always be trades that don’t work out, but they can be managed so that losses, when taken, are always small and winners are left to run.
We hold 28 stocks with gains and 8 stocks with losses in the Future Technologies portfolio I manage for Shadowridge. The tactics I have discussed here have led to more gainers than losers as of July 19, 2024. Cut your losses and let your winners run. Position sizing manages risk. This is just one example of how we think differently to help our investors.
If you have a friend or a relative who worries that their financial adviser isn’t all that “with it,” please share this newsletter with them. They may be better served by a true professional money manager who thinks differently, and that’s what we do.
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