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Happy 4th of July everyone!
I wanted to share with you this picture of the Star Spangled Banner from the Smithsonian. I had a chance to visit the Smithsonian a couple of years ago and that flag still stays in my memory and the effort that has gone into preserving it for future generations. Thank you Smithsonian.
Getting off of my patriotic platform, I wanted to spend a few moments this evening restating the purpose of this blog, my thoughts on investing, and my strategy for dealing with markets whether they be bear markets or bull markets.
Please remember that I am an amateur investor, so please consult with your professional investment advisors prior to making any investment decisions regarding your own investments. However, I have been investing for 38 almost 39 years now. I have read much, and I have had my share of losses as well as gains, and I have been distilling my thoughts into this approach which is what this blog is really about.
There are four basic parts of my approach that I would like to share with you in no particular order. The first thing I would like to discuss is the overall approach to the portfolio, that is how do I manage my portfolio, especially in response to market forces and to individual stock performance.
I have found that I am basically unable to accurately guess the future direction of the market. I do not know from one day to the next whether the market will be rising or falling the upcoming day or week or even year. Maybe others have better luck, but I don't presume this ability.
Thus, I have chosen a more passive technique for managing my portfolio. I have labeled this approach my "zen" approach, meaning that I am trying hard to listen to my portfolio, the stocks that I do own, as they through their own actions "talk" to me. (Is this too touchy-feely or what?).
Simply put, my stocks can do one of two things that affect my trading activity: they can either rise in price and reach targeted sale points, an event that I refer to as "good news"; or they can drop in price and reach sale points, an event that I refer to as "bad news." Alternatively, stocks may experience "bad news" meaning actual news that I choose to interpret as being fundamentally bad. I try not to make this judgment too often but I do reserve the right to intervene to sell stocks on these real news events.
And how do these events affect my strategy? Long ago I accepted the wisdom of limiting losses when they were small, and started to sell stocks at 8% losses. This particular rule was adopted from William O'Neill and the CANSLIM approach of Investors Business Daily. I could understand that avoiding large losses was important. However, I found myself buying additional stocks after a sale at a loss, and then rather quickly being handed an additional loss after selling the second stock at another 8% loss. In other words, the market was compounding my losses for me. This simply didn't make sense.
Thus, I have decided that after selling a stock at a loss, that I would not immediately re-invest the proceeds. Instead I would "sit on my hands" until I had a different signal that it would be time to buy.
This is where the "good news" comes in. If we are to assume that sales within our portfolios are indicative of a poor investment climate, it is also reasonable to assume that our portfolio should also be generating "good news" or signals that it is time to add a position. Since I have used a sale on the downside as "bad news" it makes sense to use a sale on the upside as "good news".
It is this good news/bad news dichotomy that drives my portfolio into equities from cash and back into cash again. I like to credit Robert Lichello who wrote "How to Make $1,000,000 in the Stock Market-Automatically with some of this philosophy and strategy that he developed to move money into and out of mutual funds by his own strategy. I use nothing like what he did, but he inspired me to think about this approach.
Since I cannot endlessly add positions, and at the same time, I cannot go down to zero positions as I use my positions to give me information, I decided upon 25 positions as my maximum and 6 positions as my minimum number of holdings. I suggest to people that they start at 12 positions, which would be "neutral" with 50% of their cash invested. Then, they would either drop down to 6 or up to 24 (or 25) on good news.
The next thing I want to touch on is my selling strategy for individual holdings that I referred to in the above discussion. First the bad news selling. As I indicated above, after an initial purchase, I sell if a stock drops to an 8% loss. When I sell on events that I refer to as "bad news", I sell the entire position, all of the shares that I own.
After making a single partial sale on "good news", which for me the first targeted partial sale is at a 30% appreciation point, then, if the stock starts to decline, I like to sell the stock entirely at break-even, keeping to the well-established doctrine of avoiding letting a stock which you had a profit, develop a loss.
However, if I have made partial sales more than once, for instance, twice: once at 30% and once at 60% appreciation points, then I allow a stock to retrace only 50% of the highest appreciation sale point. That is if a stock had a partial sale at both 30 and 60% points, then I would sell all of my remaining shares if the stock retraced back to a 30% appreciation point from the original purchase.
As noted above, whenever I sell shares on "bad news", I sit on my hands. I do not go out and buy a different stock hoping this time it would do better. I use this sale as a signal to pull back from the market. I "listen" to my portfolio!
What about sales on "good news"? Here I try to stay with my basic philosophy of "selling declining stocks quickly and completely, and selling gaining stocks slowly and partially." What do I mean by this?
I have already shared with you my strategy for selling on the downside. On the upside, I have established targeted appreciation points to make small, partial sales of my positions. While originally selling 1/4 of my remaining shares at each sale point, I realized the size of the positions was dwindling and I needed to either stretch out the intervals or reduce my sale amount. Choosing the latter, I have recently been selling 1/6th of my positions at each targeted appreciation point...and this has been working well at maintaining the size of the positions.
Currently, my targeted sale points are in groups of four: 30, 60, 90, and 120% appreciation points, then 180, 240, 300, and 360% appreciation, then 450, 540, 630, and 720%....etc. These appreciation points are rather arbitrary, but at each of these points my system directs me to sell 1/6th of my holding and to use the proceeds along with additional funds to add a new position to the portfolio as long as I am under my 25 position maximum. At the maximum, the proceeds would be just placed in cash, awaiting a future purchase.
How do I determine which stocks to buy? This is what all of my stocks that I discuss is about. Stocks that are suitable for buying by my strategy, are stocks which on the day that I have "permission" to add a new position are they themselves on the top % gainers list. Other criteria include a latest quarterly result with both increased revenue and earnings (beating expectations and raising guidance is a plus!) In addition, I want to see consistent revenue and earnings growth on the Morningstar report and positive free cash flow, without too much of a growth in the number of shares outstanding. Also, the balance sheet should show an abundance of assets and a scarcity of liabilities :). If possible, some valuation numbers including a PEG between 1.0 and 1.5, and a Price/Sales ratio not too high in its group, and a Return on equity that is high for its group. I also like to see lots of short-sellers who might be in the midst of a squeeze. I review point and figure charts and simply put, just like to see a chart with the price moving steadily higher.
Anyhow, THAT's a mouthful for this evening. I haven't talked much about my strategy for awhile, and knowing how many new people just drop by here and depart, I wanted to have another chance to share this philosophy and investing strategy that I have been employing with all of you readers and listeners!
Have a healthy and safe 4th of July!
If you have any comments or questions, please feel to write me at email@example.com and be sure to listen to my Stock Picks Bob's Advice Podcast Site
Updated: Friday, 7 July 2006 10:48 PM CDT