A Gradual Position

It is very easy to lose perspective in today’s fast markets and allow yourself to get stuck into a single set of trading tactics that may no longer be effective. The markets, like most traders, have varying cycles that present completely different opportunities at different times. To increase your trading effectiveness, learn to recognize when it may be time to adapt your disciplines and strategies.

If you are in the great majority that cannot truly day trade every second of every market day, then this article may be for you. Only the true day traders, at least those that are successful, have the advantage of not having to vary their tactics as the markets cycle. The quick “in and out” of pure day trading, if done effectively, is a tactic that need not be adjusted as it relates to micro-trading as opposed to macro-trading. In short, the ability to segment the markets down to periods of seconds or minutes, removes the responsibility of having to gauge overall direction and sentiment; a true advantage.

Let me offer one trading tactic that I consider a happy medium in the turbulent markets of today. I utilize this strategy when I want to participate in an environment that I believe carries a greater degree of risk; it removes the great rewards that day trading can offer, but also drastically reduces the risks, and yet, still allows you to profit.

Spend an adequate amount of time to identify a basket of 10-25 stocks that you feel represent great bargains at their current levels. Now, first realize that fundamental valuation is still largely undefined and open to interpretation. I always make sure that at least 25% of my identified issues are classic, or near classic, valuation issues. These are issues with attractive P/E (Price to Earnings) ratios, both current year and forward looking. I try to identify the top 3 players in those sectors that I am interested in, compare their P/E ratios, floats (shares available for public purchase), ROE (Return on Equity), analyst coverage, volume, and the 5-day chart. Realize, too, that different sectors will support varying P/E ratios. Try to find a top PC manufacturer below a P/E of 40, and you may be looking for quite some time.

Now, mix into that basket, those sectors that are particularly attractive due to recent news, volume, hype/hysteria, upcoming or recent splits, or even IPOs. Currently, IPOs are again a hot commodity, where not long ago, they had lost their luster. Make sure that you segment such sectors as the “Internet” into smaller segments such as: Retailing, Infrastructure, B2B (Business to Business), E-Commerce, etc.

With your basket filled with those issues that you want to follow, commit to keeping this list up to date, adding or removing issues as needed; but try to keep the same number of issues in your basket. Trying to follow too many issues, or concentrating on too few, will erode your performance.

Next, upon identifying an attractive entry point, purchase a 25% position. This 25% position should represent one quarter of the total amount that you would be willing to accumulate of the particular issue. You might think of this as 25% of what you would be trading if you were trading from a true day trading perspective. Usually this position will be from 100-500 shares. I like to take my first position following a dramatic market, or selective issue, decline. depending on the news of course.

Now that your position has been established, the waiting game commences. Should you encounter further weakness, and you are comfortable in the research you have done, you add your second 25% position, for a total of 50%, and at a reduced average cost. You are now prepared should your issue break out, and you still have capital to take advantage of further weakness. Upon further weakness, you must reestablish your confidence in the issue, as your next entry will leave you with a 75% position. I usually like to withhold adding my next 25% position until the issue becomes dramatically weaker, or when the issue rises to my avg. cost basis. On selected issues, with those that I have the utmost confidence in (i.e. BKS), I find myself hoping for further weakness; the old Buffet axiom is that, in the short term, you want your favorite issues to get cheaper, so you can buy more of them. In most cases, I never add the last 25%. If the stock moves higher, I am inclined to take profits, lower, and I reevaluate the position once more and move it to my intermediate term account, or cut it altogether. In rare cases, I will add that last 25% position into further weakness.

By now, you can see the advantage of this tactic. Extended market weakness still poses a risk, but as long as you allow yourself adequate time in between positions, you should be able to capitalize on short-term market weakness or strength. Be careful not to add successive 25% positions too quickly. Only in extremely rare circumstances will I take two 25% positions on the same day, and as it happened, the price spike mid-day allowed me to take my profits and close the trade altogether.

Give this tactic a try if you are looking to reduce your exposure yet still want to profit from your trading activities, there is nothing wrong with getting a little extra sleep.