How To Invest In Rising Assets With An Exit Strategy (With Fancy Math)
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
RSS Headlines
Fool UK