You seem to advocate averaging into new positions of select stocks in this market. However, what guidelines do you use for setting stops? (January 8, 2001)
You are correct in saying 'in this market.' We are usually not ones to buy into stocks that are not showing us a great pattern that is worthy of buying into. This is one of those rare occasions, however, where another party of history is on our side, i.e., when the Fed starts an easing cycle. We have already had a bear market in the index holding most of the market leaders (the Nasdaq), and many of the stocks that continue to show strong earnings growth have been sold down along with the rest of the followers. As we have been saying, we know these leaders will post the best earnings and attract the most future investor attention. Thus, we are willing to start building positions in these stocks at this time.
As for loss cutting rules when we average in we tend to stretch the rules. Remember, the only reason we are averaging in is because of the extraordinary circumstances we see. Right now we have the Nasdaq trying to hold in the 2250 and above range. While it does that we are willing to hold onto the positions we are building. None of our positions we are currently averaging into were taken back when the Nasdaq was at 3,000; we have started this just recently when we felt a rate cut was imminent. Now if you own a position in one of these leader stocks taken then and did not sell, there is nothing wrong with averaging into that position now. Nothing at all. What we will watch on these new positions, however, is whether the Nasdaq can hold at 2200. If it changes its character even with the current Fed rate cut, we don't want to take big losses and ride positions down further. At that point we would cut losses on those positions that were 8% or more down (we would not want to take more than 25% loss) to keep our powder dry for when the index found bottom when the Fed cut rates again. Indeed, if the market turns significantly lower and starts hitting new lows and beyond, we doubt another Fed rate cut would be far behind. Our goal would be to not let losses pile up and have to dig ourselves out of a deeper and deeper hole.
This is a matter of personal preference as one can continue to average down in positions that were taken substantially higher. Our usual goal is to limit downside as much as possible. We are averaging into what we believe are great stocks that are not far from once again rising with power. If that proves to be wrong, we need to exit and save what we can for the next rise.
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