A reader asked about throwing in the towel on a stock. She asked about averaging down on a premise you really believe in.
A lot of people do average down. You hear comments from these guys saying they just bought in and they hope it goes down so they can buy more. I cannot say those folks are wrong but that is not how I like to look at the world.
In a big picture sense of the question if I think I am wrong I sell. For example a while back I owned Symantec for clients. The premise makes sense, we need internet security, everyone I know uses their software and renews it every year. I bought the stock around $30 and gave up at around $20. I still don't know what went wrong. A little over a year ago I had three stocks trade similarly (in terms of downward price action) and sold them all. I could have sold earlier but did not. That quarter I lagged the market slightly.
Being diversified makes the consequence of this type of mistake less severe.
To the reader's question when I buy a stock I buy a full position. It will either be right or wrong, is how I view it. If I buy a stock with a 3% weight and it drops 20% how much would I add? Would commission get in the way? Are the stock peers down the same or not?
A part of my stock picking is so that the stock will capture an effect or two. If I want to own a European drug company to capture three different things it would make sense to follow up whether the stock is in fact capturing those effects. If telecom falls by 25% and my telecom stock falls 24% or 26%, that is not necessarily a sell. If telecom is up 3% and my telecom stock is up 30% or down 30% then it may be a sell.
One theme to my portfolio construction is to not inflict too much damage when I am wrong about a stock. I think the worst stocks I have owned were sold down about 30%. I believe this has only happened with stocks that were originally bought with a 2% portfolio weight. The hit in the example is 60 basis points to the portfolio. That is not a big deal.
If I keep buying I would make it worse. The bigger picture assumption here is that everyone will get stock picks wrong. We cannot know what stocks we will get wrong either. So the long-winded answer is I do not average down. It would be easy for the reader to find a compelling argument to do the opposite but that is not for me.
On a different note Jason Trennert was on Bloomberg TV this morning and when he wasn't being interrupted by Brian Sullivan he recommended Citigroup, Intel, Pfizer, Genentech, Amgen and I think Cisco. Who knows, maybe the 87th time will be the charm!
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8 comments:
"Losers average losers"
---Paul Tudor Jones
That pretty much sums it up!
Linda P.
"Losers average losers". Yup. That's it alright. I have that taped to one of my monitors. I never average down. It's a losing game.
Agreed in principle, but averaging down can be turned into a winning dollar cost averaging game. For example, put some cash in a money market fund at Vanguard and invest a portion of the interest in a good fund via automatic transfer, every week or month; then, if the fund goes down, increase the periodic investment; if it goes up, decrease the periodic investment. I've been doing this with considerable success for years.
Roger,
It is important to distinguish between a good stock investment and a good company. When I purchase a stock in what I think is a good company and the stock declines, the company is still good, but the investment is not.
In general, it is best to bias your portfolio towards gaining stocks by selling your losing stocks quickly and completely and selling your winners slowly and partially. It is this bias in portfolio management that in itself will tend to build a successful portfolio.
Thus, instead of averaging down, I bail out of declining stocks, at an 8% loss level which is an idea which I borrowed from the William O'Neil CANSLIM crowd.
So instead of thinking that the entire market is wrong about an investment and that I was right, I recognize the "error of my ways" and move on. I think this strategy, difficult as it is to implement, is the right way to go.
There have been a few stocks that later move higher, but overall, this approach has limited my losses and allowed my gains to run.
Bob
Petronius,
There is a large difference between dollar-averaging in a mutual fund that is really a reflection of a manager who already is developing a portfolio and averaging down on a declining stock. The risk of averaging down is far greater with a single equity.
I do believe that dollar-cost-averaging on well-run mutual funds which already have a diverse portfolio behind them can be quite successful for the average investor.
Bob
While my experience is with mutual funds, not individual stocks, several big returns were from averaging down. When I first bought into emerging markets, then fund started down about 20% and I made several buys. The last buy was half-hearted, but those few shares are up almost 100%, so I wish I had added more.
My experience buying into REITS was similar, but the initial downside was not quite as severe.
If you think your original call was good, why not load up a bit? It seems to me the advice about losers can be countered with the slogan about chasing returns and how individual investors underperform the market: they sell when something drops and put the $ into a hot stock/fund/sector that tops out on them.
Paul
My worst experience with mutual funds around 2000 was refusing to sell even when the gains were dwindling. I had Janus Global Technology fund and had over 100% profit at one time but when I finally sold it the gain was something like 10%. This brought me to a book that is called "How to make $1,000,000 in the stock market automatically" by the late Robert Lichello. Lichello showed you can make respectable profits by buying when the stock is going down and selling when the stock is going up using a purely mechanical method. I want to remind people while averaging down may sound like a loser but not necessarily so if you know when to sell.
In fact a lot of dissatisfaction with brokers and advisors is due not to having bought the wrong stocks(or funds) but not selling your stocks(or funds) when you should.
Savy investors should know by now the entire financial industry is tilted predominately toward the buy side advises and services and woefully lacking on the sell side.
High Alpha
High Alpha,
Great comment on Lichello. His AIM system really works well with mutual funds that are high-beta, that are volatile and move up and down faster than the market. Individual stocks do not necessarily fluctuate the same way that we can expect a fund to fluctuate. Instead of reflecting the overall market or sector, a single stock can reflect that particular company and management and cannot be depended on to always bounce back. Thus, averaging down is dangerous and may aggravate a losing position.
Good point on the bias to the long side! I agree with you on that, but the bias of the entire market is higher. Thus, to go against the market on the short side is also riskier than going long.
Bob
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