When is it Ok to Average Down?

Just remember one thing…

…that the words “averaging down”…

…only go with long-term investing. 

They do NOT go with trading. 

After you have fully digested and understood the above, let’s to to the when. 

When does averaging down go with investing?

The answer to this is – only after doing proper homework. 

If you’ve not researched the underlying well enough, don’t even think about averaging down, because you could be throwing good money after bad. 

When there’s a correction, the long-term investor does get tempted to increase his or her holding, because of the lucrative prices that are on offer. 

Sure, why not?

Please understand, that this “sure, why not” is coming out so casually because of course the long-termer has worked overtime to arrive at the conclusion that he or she wishes to increase his or her stake in something that is already being held. 

The fall in the price of the underlying does not perturb the long-termer. Solid research has been done, and the markets make huge mispricing blunders when in free fall. Market players go all psycho and discard their precious holdings at throw-away prices. Picking up quality stocks at bargains is exactly what the long-termer is in it for.

The long-termer has done a few more things. 

Family has been secured with multiple income-sources and emergency funds. What’s going into the market is sheer surplus, not envisaged to be required over the next ten years. 

Then, entry quantum is small each time, small enough so that entries can be made all year round, and there will still be ample savings left after all entries. 

How does one calculate a small enough entry quantum that satisfies all of the above criteria?

One works backwards. 

Pinpoint your income after tax for the year.

Decide what you wish to amply save. Subtract this from your income. Further, subtract expenses. You are left with an amount. Decide whether all of this amount can go into the market, or whether only a part. Maybe you wish to go for a holiday with your family, or perhaps you wish to buy a vehicle, or what have you. Subtract such additional expenditure too. Finally, you are left with the amount that you wish to plough into the market, over the course of the year. 

Next, take the amount, and divide it by 30, or 40 or 50. 

Why?

On the down-side, the market could offer you margin of safety on 30 of the days that it is open in the year. On the up side, the number could be 50. We are talking about ten-year average numbers. During a singular correction, the market could offer margin of safety continually for the whole year. Decide what your magic number is. 30-40-50 days per year works ok over a ten year period. Divide the amount you’ve set aside with the number you’re comfortable with to arrive at your entry quantum per entry-day, for the year in question. Now you can keep going in with this same quantum through out the year whenever margin of safety is offered, and you generally won’t have to worry about running out of investing money, on average. 

Great stock-picking, excellent due diligence, surplus going in, small-enough entry quantum, ability to sit – the long-termer is armed with these weapons, and now, he or she can average down as much as desired, whenever margin of safety is offered.  

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Margin of Safety and Trading

MoS and trading have a somewhat funny relationship.

When MoS is offered, you don’t feel like looking at your trading portfolio.

Why?

Because it is bleeding?

Maybe.

Actually, you are in a hurry to clock some long-term investments. After all, there’s MoS on the table. Yes, you’d much rather occupy yourself with your long-term portfolio.

With serious MoS in the pipeline, the market makes it easier for you. It bludgeons your trading portfolio, such that you sheer exit it, and now you are free to focus solely on your long-term investing portfolio.

Fine. Great. Is that it?

There’s a tad more to the connection between MoS and trading.

What is trading?

Buying high, and selling higher? Selling low, and buying back lower? Yes, that’s trading.

On first instinct, you’d buy on a high, or sell on a low, that’s what you’d think.

However, on the ground, margin of safety makes itself felt.

Players wait for the underlying to correct a bit, or rally a bit, and then pick it up, or sell it. They’re not picking it up on the fresh high, with no resistance opposing them. They are taking a chance, that there will be a correcting move, and that’s when they will pick it up. Vice-versa for the bears.

Those few extra buck of fall will add to their profits when the underlying starts to rise again and makes new highs. Expressed for the bears, those few extra bucks of rise will add to their profits when the underlying starts to fall again and makes new lows.

The pay-off is, that this doesn’t always work. The trader might miss the trade altogether, if the correcting or rallying move does not take place, and the underlying zooms (falls) to make one high (low) after another.

So when does waiting for MoS actually work in trading?

Almost always. Except…

…when it’s a full-blown bull or bear run.

This means that it works like 90% of the time, which is a pretty high number.

Does that make you want to adopt MoS full-time while trading too?

Of course it does.

How do you still make use of the opposite strategy – buying upon highs, or selling upon lows?

You let a few setups go amiss. Missing a couple of trades due to bull or bear runs is the signal.

Now you can switch to buying on fresh highs or selling on fresh lows.

A Small Entry Quantum per Day Keeps the Doctor Away

Your ears are probably swelling from all this talk about a small entry quantum (SEQ) per day.

However, you are also noticing the practical element of the SEQ, especially during the current correction.

Whatever’s happening in the world is happening. We need to long-term invest on the basis of what’s being offered to us. When we see margin of safety, we act.

However, we could go on seeing margin of safety for years upon end. Therefore, our entry quantum per day is small, so small that we can last out purchasing for quite a while, and still have ample liquidity left over for all other necessary aspects of life.

There’s another benefit of the SEQ though.

Let’s say that one of your holding turns rogue.

It can happen. So many scams are emerging. There’s a new scam every day.

So let’s just assume, for assumption’s sake, that the management of one of the stocks you are holding is involved in a fraud, and this fraud has come to light.

Where does that leave you?

You stop accumulation of this stock immediately.

Don’t expunge it yet. You’ll lose out. What if the scam is a hoax? Find out. It might blow over. Management might change. Your conviction in the stock might be rekindled. Wait for a market high. If you’re still not convinced about the stock anymore, expunge it on a market high.

What did the small entry quantum do for you here?

You had accumulated the stock over some kind of period, SEQ by SEQ, right?

When the fraud exploded, your holding wasn’t that sizeable. SEQ, remember.

A fraud management won’t wait multiple years to let their fraudulent natures act. Sooner or later, a fraud will get caught. Sooner the better. When this one is caught, your holding is not enormous. It’s size depends upon the number of years of holding and conviction.

The greater the conviction, the longer the holding and the lesser are the chances of the management consisting of fraudsters.

Your small entry quantum has ensured that over many, many years, stocks that end up getting accumulated majorly are the ones where conviction strengthens year upon year upon seeing multiple practices of good governance and shareholder-friendliness.

Scammers stop getting accumulated long ago. They are expunged on market highs.

After a decade or two, your portfolio is brimming with honest multibaggers.

Wave Buying upon Prolonged Corrections

Where there are markets, there are corrections.

At first, they cause us dismay.

Slowly, we get used to them.

Then, we start using them.

Next step is – exploiting them.

One can speak of exploiting if a correction persists, and one is long-term investing.

During a persisting correction, we purchase in waves.

How are we defining a wave?

Go through your long term portfolio and pick out those stocks that are offering margin of safety.

You convince yourself of their health once again. Still healthy? Go ahead.

You purchase them one by one, one per day, by putting one entry quantum into the market for each purchase.

There will be greed to buy more than one underlying in one day. Don’t give in. This will allow your buying power to persist alongside a persisting correction.

The size of your entry quantum needs to be small enough to sustain entries all year round, still leaving ample liquidity on the side. Your long-term strategy should not immobilise your financial and familial activity in any way. Thus, an optimally small enough entry quantum is vital.

You’ve gone through a wave.

Breathe.

Correction persisting?

Go through your long-term portfolio again.

Where does margin of safety still exist? Pick out stocks list.

Go through next wave.

Repeat.

Till when?

Till no margin of safety is offered, or if you feel that the buying limit with a stock is surpassed.

4-5 such waves can really ramp up your portfolio.

What happens if corrections continue over multiple years?

Take long breathers between sets of waves.

Keep doing due diligence. If you’re not convinced about a stock anymore, don’t include the concerned stock in the next round of wave-buying (you can exit such a stock completely upon a market high; wait patiently for such a high and then throw the stock out, if still unconvinced about it).

Yes, ultimately, markets will start to rise again. Margin of safety dries up. You stop buying.

Your portfolio will now start showing its health.

Why?

It’s been accumulated with conviction, at the right price.

Congratulations.

🙂

Personal Long-Term Investing Isn’t about Establishing a Mutual Fund

If it were the case, why bother?

Just put your money in a mutual fund instead. 

There are many competent fully equity-oriented mutual funds out there. 

Some of the competent ones have very reasonable expense ratios and eye-popping statistics. 

Investing in a mutual fund takes away your work-load completely. 

You put in the money for the longish-term, and then you’re done. Don’t bother for the next 5 years. 

If you’ve chose the dividend payout option, you get an SMS or an email maybe once or twice a year that puts a smile on your face. It’s a payout!

What is a mutual fund?

What’s so mutual about it?

You mutually agree to what the fund manager is doing. 

Thus, make sure that the fund-manager is competent. Study the fund-manager’s track-record. 

A mutual fund typically consists of 50-75 stocks. Some are weighted heavily, some more lightly. 

The return you get is the mathematical average of the 50-75 stocks, adjusted for the weight they carry. 

It would suffice here to say, that the MF delivers some kind of an average return, less all kinds of fees, which typically range around the 2.5% mark per annum. 

Therefore, as far as returns are concerned, after tax deductions, one is probably left with a high single-digit one or a low double-digit one, in the long run, compounded. 

Not too bad.

Remember, this is equity we are talking about. Equity is an asset-class which gives returns that are adjusted for inflation. 

Actually, great. 

Those of you who are satisfied with this need not read any further. Just go ahead and put your surplus funds into MFs.

However, some of us want that extra kick. We are not satisfied with low single digits. We want 15%+, per annum compounded, after tax and adjusted for inflation. 

This is not greed. 

Ambition perhaps. 

Drive. 

Renumeration requirement for the arduous work put in. 

We’ve struggled. 

We’ve gotten hit many, many times. Each time, we’ve stood up, taken the hit, and carried on.

We have learnt. 

All for what?

Now it’s time to cash-in.

We go about setting up our long-term portfolios in the proper fashion. 

Total number of stocks eventually in the portfolio needs to be well clear of the MF mark…otherwise, right, why bother.

MF-type diversification will give an average return. 

We will build a focus portfolio. 

Focused returns are higher in the long run.

What’s the magic number?

Well clear of 50-75 stocks in all is understood. For me, even 40 is too much. I could deal with 30, though. Hmmm, let’s steer clear of the 3 in 30, so 29 is good enough for me as a maximum. The pundits are satisfied with 15-20 stocks, no more. Focus-gurus swear by 10-15 stocks. I’m ok with a maximum of 29, (a limit I’ve not reached yet) because in reality, I just hold 6 sectors, and multiple underlyings within the sectors. Thus, even with a maximum like 29, the 6 sectors alone make it a focused portfolio. 

The bottom-line is focus. 

As long-term investors doing it ourselves, we are going to focus. 

Staggered entry. 

Small entry quantum each time, many, many times. 

How small?

Small enough, such that one can enter about 30 or so times in a year and still have ample savings on the side from one’s earnings. Why 30 or so? That’s a rough 10-year average calculated per annum, estimated by me, during which one gets margin of safety in the 220 days or so that the markets are open in the year.

There we are : focus-investing, margin of safety, staggered entry, many, many entries, small entry quantum each time and generation of ample savings despite equity exposure. 

Is that a formula or is that a formula?

🙂

When it Pinches, Then You Buy

What is a good time to buy for the long-term?

Is there some kind of formula? Mathematical equation? Algorithm?

Who doesn’t look for the holy grail?

Sure, there are technicals galore, to assist one’s buying and fix its appropriate time. 

Of course, fundamentals, when studied properly, are even more helpful. 

However, neither technicals nor fundamentals can replace emotion.

The emotional alarm, when sounded, is a good time to buy for the long-term. 

Surprised?

Here you are, getting alarmed at how the markets are falling. 

How are you supposed to buy with a straight face amidst the panic?

That’s just it. 

Markets are wired in an opposite fashion to our mentality. 

At the onset of margin of safety, our mental framework emits panic upon seeing the mayhem. 

Upon the vanishing of margin of safety, the same mental framework emits euphoria and wants to participate in the rally. This is trading, not long-term investing, and as long as you buy high and sell higher, you are good. What you are not going to do here is hold your trade for the long-term, thinking it’s a long-term buy. What has not been bought with margin of safety is not a long-term hold. 

Why?

Margin of safety gives us a buffer. 

Let the markets fall; they still don’t reach our entry price. Or, they only fall a tad under it, and then start to rise again. That’s the beauty of buying with margin of safety. You can use the low now created to pick up some more, if you are still convinced about the stock. Otherwise, you can always exit the stock on a high. 

In long-tem investing, one should not exit on a low due to panic. If one does so, it’s like market suicide. 

What causes exits on lows?

Panic. 

Need for money.

Weak hands. 

Become a strong hand. 

Put in only that money which you don’t need for the next ten years. Make sure before entry that you won’t be pulling out this money in the middle of the investment if you can help it. Have a fallback family fund to lean on ready before you start putting money into the market for the long-term. 

Teach yourself not to panic. Rewire yourself alongside the market. This takes time. It took me almost a decade to rewire myself. Everyone needs to go through this rewiring process.

Once you’re rewired and  financially secure, your strong mind will pick up on the emotional trigger, and will start buying when the pinch-factor kicks in. 

Your strong hands won’t let go owing to panic. 

In the long run, your investment, which has been made with margin of safety and proper due diligence, will yield you a fortune.

Happy investing!

🙂

Useless vs Useful Expansion

I’m guilty of useless expansion. 

I end up doing it all the time. 

Can’t help myself, you see.

I like to keep exploring new stuff in the market. 

The silver lining is, the even though I might be expanding sideways, there are two good things happening also. 

There is no scaling up happening immediately. Good. 

There is also a lot of discarding going on. Things that don’t work out are eventually abandoned. Great. 

My issue is that I might have between 1 to 2 useless strategies in my repertoire at any given time. 

These strategies are not working. In fact they are dying out. Reasons can be many. A strategy might be sound, but it might not be a fit. 

For a strategy to work for you, it must be practically lucrative in the long run, and it must fit you. 

By the time I realize that a strategy needs to be discarded, money has been lost. Tuition fees? Yes. 

Ultimately, things boil down to a handful of successful strategies. It can even ultimately boil down to one or two successful ones.

Get there. I’m trying too. To do so, useless strategies will need to be discarded, like, now. 

The problem is, you don’t know that a strategy is useless till it has hit you a few times. 

Also, you don’t wish to discard something that you think might just work out for you in the long run. 

Fine. Keep grinding, and ultimately narrow down your sideways expansion, till you’re only working with strategies that are yielding, and show a long-term promise of being around. 

Right. 

You’re there. 

Now you can scale up. Doing so using a yielding strategy that fits is called useful expansion. 

Scale up slowly. 

You can position-size, and scale up using profits. This way you are not putting in extra principal. Let the strategy continue to prove itself by yielding. As long as it does so, you keep scaling up on your positions using the newly earned profits. 

Why is useful expansion not easy to maintain?

We get carried away.

We might scale up too fast, and then baulk at a loss when the size of the loss is too difficult to swallow. Large input can result in a largish potential loss.

Trading is about containing loss, and letting profits run. 

Scaling up too fast makes an early loss look big if we haven’t tasted the corresponding potential profits yet. Such an event can even cause us to abandon a successful strategy because we are disheartened. 

Therefore, try not to scale up by putting in new principal, if you can help it. 

Try scaling up on profits alone.

Position-sizing automatically controls the scale-up-scale-down factors by defining the size of a constant stop as a percentage of the principal remaining between trades.

Position-sizing makes one scale-up and scale-down on auto-pilot in a relatively balanced fashion.

Please incorporate this wonderful ideology (which comes from the stable of Dr. Van Tharp) into your trading strategy. 

🙂