Rome wasn't built in a day, why should your positions be?
Whether Day Trading, Swing Trading, or Investing Long Term, I typically build positions. There are times when I go all in from the start, but I build around 90% of the time. Here are the steps I take.
- The obvious first step is to come up with something you like after some analysis.
- Once you find your play, decide how much capital you want to devote to it. Keep portfolio management in mind.
- Start with a small position. I typically start with 1/4 of the capital I am willing to devote to the play.
- If your play is working, add to it. Base the amount you add on the performance of the stock. If there's massive volume and/or it seems very clear to you that the play is solid, add another 1/2 of the capital you are willing to devote (which puts you at 3/4). If you like it, but still feel a little skiddish, add another 1/4.
- If the play continues to work, add the final portion of the capital. Now you are fully vested and should not continue to add unless you are comfortable doing so from a portfolio management perspective.
You may be thinking "This is stupid! I will lose money by adding at higher prices. If I like a play, I'm going all in from the start." You are correct, you will miss out on some gains by adding in increments at higher prices. That said, this is a risk management strategy that wins in the long run. Face it, your picks lose more often than they win. If you reduce exposure at the start, you will face a smaller capital loss if the play goes against you. This helps you find winners, cut losses short on losers, and build on winners.
Give it try. I think you will like the results.
Side Note 1: Be sure to track and compare results when testing this strategy versus an all in strategy.
Side Note 2: Correlate the add with the time period of the stock trading strategy. If you are Day Trading, you will want to add fairly quickly. If you are Swing Trading, you can wait a few days before your first add if that's how long it takes to make you comfortable with the play.
Side Note 3: Options are another story. I'll get to that very soon.
Related links: intrinsic value, extrinsic value, implied volatility,