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How To Invest In Rising Assets With An Exit Strategy (With Fancy Math)

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April 21, 2011 – Comments (16)

I appreciate that Fools new to rising commodity prices are concerned with "how do I get out? what is my exit strategy?"  In fact, if you are investing rather than saving, here is a way to protect your gains no matter if it's silver, a silver miner, or a hot biotech stock.  It works in a secular bull market and it works in a bubble.  (So you don't have to spend your time in that ole argument if you don't want.)

And I'll show you the mathsssssss.

(Throughout this post, keep in mind that this is not to be done with your rainy day fund money.  Rainy day fund strategies can be discussed in the comment section if you like.  I do not recommend investing in anything unless you already have a rainy day fund.)

Halving Up

I don't have a name for it, so I call it Halving Up.  It's not my own strategy.  I would love to give credit, but I don't remember where I heard it. Sorry to the originator.

Let's use the example of silver. Everyone loves silver these days, it seems, no matter your economic leanings. But where's the top? I say, who cares. Watch closely.

I'm Joe Investor. I just watched Glenn Beck and he told me that Socialism is running rampant in America. (It just started yesterday, appearantly.)  I'm going to make my initial investment in silver, using SLV ETF, at the opening bell.  The spot price as of this writing is $44.12.  We'll go with that.  I want to invest the $10,000 that I was going to give to that Televangelist with the wavy hair and chestnut eyes.  

(Let me have fun with the Tea Party crowd. I've been taking Progressives to the shed lately.)

I buy 225 shares * $44.12 + $9.99 (I use ETrade because talking babies are funny) = $9,936.99
My initial cost basis is $44.16/share

Now again, where's the top?  Is it $50?  If so, why are you buying?  Is it $100?  Cool, that's what I heard from some guy on the radio! Is it GOLD-SILVER PARITY PARTY????  Again, who cares?  Watch closely now.

If SLV doesn't move, you do nothing. Sit there and twiddle your (hopefully) opposable thumbs until you come up with a better idea.

If SLV goes down significantly, we'll just say to $35, you sell.  Have a sell point in mind if the trade doesn't work out.  Period. End of Story.  You suck. Your timing sucks. You missed the boat. Forget silver. Never think about it again. Never. 

Look, just like in poker, when you throw that 37o into the muck before the flop, you forget it immediately! That way, when the flop comes 3-3-7, you don't make that face that annoys everyone else at the table because now you've just implicitly table-talked and impacted the hand for the remaining players. (The preceeding paragraph in no way implicates me as a poker player subject to criminal prosecution by the FBI.  It was just an example that appears to be based on many past experiences.)

I'm only half-kidding here. Of course, you can try again if it reverses back upward, but this is a trading strategy, which means you need a short memory and you can't be emotional.  Forget it ever happened.  Even when you jump back in.

But silver doesn't go down. It goes up, just like your idol Ann Coulter said it would.  She knows that the price of silver is directly proportional to the number of terror plots she uncovers. And that number is always rising.

You wait until silver rises 25%. SLV is now $55.15.  You buy in a size that is half the amount of your initial investment ($5,000). You buy 90 shares. 

90*55.15+9.99 = $4.973.49

Now check the stats:

Total shares owned: 315
Total cost: $14,910.48
Total cost/share: $47.33

(Including purchase)
Balance: $17,372.25
Profit: $2,461.77
Gain: 14.17%

(Don't try this without a spreadsheet!)

So after halving up the first time, you are up 14%.  Now, the fun starts.  SLV gains another 25%  above the level of your most recent purchase (to $68.94.)  So you halve up again:

35 shares * $68.94 + $9.99 = $2,422.80 <------- Notice that this is almost exactly half of your last purchase size

Now check the stats:

Total shares owned: 350
Total cost: $17,333.28
Total cost/share: $49.52

(Including purchase)
Balance: $24,128.13
Profit: $6,794.84
Gain: 28.16%

Well, I'll be damned, it's a miracle. Silver is headed for $100. Lets' see what happens after another 25% runup. 

14 shares * $86.17 + Talking Baby Fee = $1,216.40

Now check the stats:

Total shares owned: 364
Total cost: $18,549.68
Total cost/share: $50.96  <------- Look at your cost basis

(Including purchase)
Balance: $31,366.56
Profit: $12,816.88   <------ Enough to buy a commemorative bass guitar signed by Mike Huckabee
Gain: 40.86%

Look out below. Mitch McConnell just announed a bubble in silver at the behest of his bank lobby. Are you worried?  If so, you could always by puts at a strike price of $70 and lock in some profits. Up to you.  In the meantime, since he's the last to know, we watch silver break $100.  Here's another 25% upswing.

6 shares * $107.71 + $9.99 = $656.28

Stats, please:

Total shares owned: 370
Total cost: $19,205.96
Total cost/share: $51.91

(Including purchase)
Balance: $39,854.49
Profit: $20,648.53 
Gain: 51.81%  <------- Do you feel safe that you can get out during a sell-off yet?

Hey, just for old time's sake, even though we are low on bullets, let's do it one last time. It turns out silver still has some juice.:

2 shares * $134.64 + $9.99 =  $279.28

Stats, please:

Total shares owned: 372
Total cost: $19,485.23
Total cost/share: $52.38

(Including purchase)
Balance: $50,087.40
Profit: $30,602.17
Gain: 61.10%

And that's it. You're out of bullets. If silver continues to climb the charts, sit back and enjoy the ride. You did the best you could. Find another investment to start this process all over again.  

The Obvious Big Advantage

You don't have to guess the top.  When the top comes and the stock heads the other way, sell. In this example, if SLV drops 25% after you've made your last purchase, you still walk away with a hefty profit. If you can't get out during a sell off faster than that, what are you doing?  Look, if you can't bring yourself to sell when a stock reverses, no Exit Strategy is going to help you.  Halving Up is not called Halving Down.  Just sell.  Take your profits.  There are other fish in the sea.

You also don't have to catch the bottom. As long as you get in during a rise, this strategy will work. So you don't have to fret about missing out on the big move. If the move lasts long enough, you'll do fine. If not, take whatever profit you can and try again.

Some Obvious Points

If you are a terrible stock picker or you just have the worst luck in the world, you will take some hits.  That's why it's important to use this strategy only for rising assets.  Do not under any circumstances use Halving Up to catch a falling knife. That's a totally different ballgame.

The more money you have, the better this strategy works, simply because you can keep adding to your winners... if they keep winning.

But even if you start small, catching a few winners and riding them out will drastically change the size of your gun for next time. Be patient.

You can diversify with this strategey. Let's say you have $20,000. You could put $5k on slv, $5k on slw, $5k on gpl, and $5k on porte's favorite pick just so he's not left out.

As your winners rise, consider how much you have gained in comparison to how much of a reversal you can stomach.  Insure yourself accordingly.

Summary

Set up a spreadsheet and play with the numbers. Change the percentage before Halving Up to 50%. See what happens. Change it 10%.  Use past examples of rising stocks. 

This is a trading strategy, not buy-and-hold.  But it's not a day or weekly trading strategy either.  When you find a good asset to purchase and you get in on the rise, it could be a weeks or months before you make another trade.

So don't take this as the be-all-end-all. It should not be your overall philosophy. Just a part of it. It's just one example of how you can get in on a bull market without getting burned.  Like I said, if your timing is so bad that you buy right at the top, well.... at least you only lose on your initial investment.  It could be worse.  And if things go your way, it could be very good.

Comments welcome.

David in Qatar

16 Comments – Post Your Own

#1) On April 21, 2011 at 2:14 AM, whereaminow (20.06) wrote:

Stupid Spreadsheet (operator error, actually)

Profit totals are correct, but percentage gains are underestimated (formula pointed to the wrong cell):

1st 25% = 16.51%
2nd 25% = 39.20%
3rd 25% = 69.09%
4th 25% = 107.51%
5th 25% = 157.05%

That's more like it.  Rest of the calcutions passed the 2nd check. I don't do maths.

David in Qatar

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#2) On April 21, 2011 at 9:29 AM, saunafool (98.58) wrote:

One comment: How do you know where the top is?

I mean, isn't that ultimately the problem with any trading strategy? Value guys sell when they think intrinsic value is far exceeded by the price; technical analysts try to sell when the chart tells them; I generally like to sell in the midst of my despair so that I don't have to pay taxes on any stinking gains.

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#3) On April 21, 2011 at 10:07 AM, mtf00l (44.68) wrote:

whereaminow,

Awesome post! What can I do with $200?

saunafool,

That's too funny... " I generally like to sell in the midst of my despair so that I don't have to pay taxes on any stinking gains."

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#4) On April 21, 2011 at 10:21 AM, kdakota630 (29.42) wrote:

Good blog, as usual, although this is one of the rare ones that I didn't fully enjoy.

Why not?

Nothing on your end, just my own short-coming.  This is probably the 3rd of 4th time recently that I've seen 37o referenced, and I have zero idea what that is. And then you talking about a "flop" and I'm asking myself "wtf?"  To me, a "flop" is something I do in bed when I'm really tired or drunk.

Other than that... well done.

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#5) On April 21, 2011 at 11:18 AM, FreeMarkets (90.47) wrote:

David - I have to disagree when you wrote: "If you are a terrible stock picker or you just have the worst luck in the world, you will take some hits. "

Terrible stock pickers are even better than good stock pickers.  If they are really that bad, then simply do the opposite.  Consistently wrong is as good as consistently right.

I heard a stat once that 80% of all day traders lose money.  I want to open a day trader website that randomly reverses three out of every four trades someone makes. 

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#6) On April 21, 2011 at 11:23 AM, whereaminow (20.06) wrote:

kdak,

37o is a 3 and 7 of different suits (the o stand for off suit).  It's a terrible starting hand in Texas Hold Em.  It's also one of my favorite hands because nobody sees it coming hahahhahhaha

(don't try that at home)

David in Qatar

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#7) On April 21, 2011 at 11:36 AM, Jbay76 (< 20) wrote:

ROTFL......I love your comment kdakota630

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#8) On April 21, 2011 at 12:59 PM, leohaas (31.90) wrote:

Nice idea! Have you tried this with real money?

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#9) On April 21, 2011 at 1:03 PM, whereaminow (20.06) wrote:

leohaas,

Thanks!  Only recently, so I can't brag about how much money it has made me yet. But if silver continues to rise, my recent mining purchases should provide ample opportunity to see results.

David in Qatar

 

David in Qatar

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#10) On April 21, 2011 at 2:45 PM, Valyooo (99.33) wrote:

(The preceeding paragraph in no way implicates me as a poker player subject to criminal prosecution by the FBI.  It was just an example that appears to be based on many past experiences.)

Paranoid, eh? ;)

I agree with this...silver and gold are the opposit of stocks...you buy them when they are consistently going up, as opposed to investing in stocks where you want to average down

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#11) On April 21, 2011 at 2:54 PM, whereaminow (20.06) wrote:

Val,

Paranoid, eh? ;)

Like any hack writer, I like to beat topical jokes into the ground. I suppose I should come up with some new material.

David in Qatar

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#12) On April 21, 2011 at 3:58 PM, chk999 (99.97) wrote:

Great writeup. How about a writeup on detailed exiting? Selling seems to be much harder than buying.

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#13) On April 21, 2011 at 7:29 PM, whereaminow (20.06) wrote:

chk999,

Thanks. I like this strategy because it is really helpful for people that are bad at pulling the trigger and getting out at the right time. It's not a perfect approach and there is no corresponding Halving Down or anything like that, as far as I am aware.  The point is that as the stock runs up, it forces you to become increasingly more conservate and keep your cost basis low.  That way, reversals will not burn you. 

David in Qatar

 

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#14) On April 22, 2011 at 12:02 AM, walt373 (99.79) wrote:

A momentum strategy is the easiest strategy in the world to understand. You buy what's going up, never hold anything that is not going up, and that's it...

The way I view halving up (I have also heard it called pyramiding) is that it is not really part of the momentum strategy, but it's a position sizing and timing strategy that you can use with any strategy. Pyramiding is the same idea as averaging down, just applied to a momentum strategy instead of a value strategy.

Alternatively, you can buy a full position right away. Or you can be more selective and only buy your initial position when most people would "halve up" for the 5th time. Or the 3rd time. Or mix and match, etc. A pyramiding strategy just combines all of these timings.

The value analogies would be, if you only buy a stock once and never average down, or if you are extremely selective and only buy the cheapest stocks (you are buying when it's in the 5th level of cheapness, similar to like when something has "5th level" momentum).

The main effect it has is, you get diversification in timing. What I mean by that is, using a pyramiding strategy, you will be buying all along the momentum spectrum... low, medium, or high momentum. At certain times, momentum stocks will fizzle out after a short run. Other times, they get stronger the longer they last. Using a pyramiding strategy ensures you are buying securities with all different levels of momentum.

Again, an analogy in averaging down in value investing is, sometimes, the market will only produce mildly undervalued stocks that immediately pop back to fair value. Other times, extremely undervalued stocks will emerge that you want to be buying. Averaging down ensures you are getting in on the action at all times.

However, I think one important thing to keep in mind about this strategy is to not let position sizing get out of control. Be sure that your final position will be a manageable size. If you are diversifying your timing but letting your positions become totally concentrated, this will obviously increase risk, defeating the purpose of pyramiding. The fact that you are on tier 5 of your pyramid because you already saw a 100% gain, does not make it OK to ignore risk management. This type of thinking is what causes people to lose their gains. You need to manage risk as it is in your portfolio currently at all times. As such, I would say if you are pyramiding, it makes sense to start with a smaller than normal position.

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#15) On April 22, 2011 at 12:11 AM, walt373 (99.79) wrote:

Also, this is actually an entry strategy and not an exit strategy as you have described it. But you can pyramid with selling as well. As momentum fades, you sell fractions of your position. Sometimes it will bounce back, and you won't get shaken entirely. As far as momentum goes though, the basic exit strategy is just to sell when it stops going up.

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#16) On April 23, 2011 at 9:10 PM, whereaminow (20.06) wrote:

walt373,

Thanks for the writeup. Like I said, I know I didn't think of it, I just couldn't remember where I heard it.

As for as the title, this blog is directed to peolpe who think "hey i'd love to get in on the silver action, but what if the bubble bursts."  Well, conservative halving up couple with proper insurance should protect you if it reverses. And like you said, freakin sell when it reverses. That's your exit strategy, since this is a simple trading strategy and not an exercise in perfecting algorithms.

I suspect our CAPS crew gets all that. And I also think that anyone who doesn't probably shouldn't try to ride a rising asset.

Again, thanks for the comments.

David in Qatar

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