“Do Half”

Before I start my piece for the evening, I want to explain why my AIG piece is slow in coming.  Short answer: It’s big, and I am still writing it.  There is a lot there, and I am trying to get it right, realizing that I am just a generalist dealing with complex issues and not enough data.  I hope to have the piece finished on Wednesday for Finacorp clients, and out be the end of the week here.

“Do Half”

What I am going to talk about here is annoying to some who always feel that investing is about taking bold actions.  I had one boss that would go nuts when I would talk about this strategy.  Other friends, akin to deep value investors, would get perturbed as well.

I used this strategy extensively when trading corporate bonds 2001-2003.  I was a fairly active trader, unlike what I do with equities today.  Yet, even with equities, my rebalancing trades which have aided me in this volatile market, mimic some of the benefits of this strategy.  Here are some examples:

1) Say you bought a stock and it rapidly rallies, yet not to the point where you think it is at fair value.  Perhaps recent events have made you re-estimate fair value upward.  What to do?  Sell half of the position, and wait.  If the price falls, buy back the position.  If it rallies further, sell the rest.

2) Say you want to buy a stock, but it is plunging like a stone.  You’ve done our homework — the balance sheet is strong enough to self-finance the company for three years, estimated earnings for the next indicate the company is cheap, what to do?  Buy half of a full position, and wait.  If the companies rallies sharply, sell the position.  If it continues to fall, wait until it stabilizes, confirm your fundamental research and buy up to a full position.

3) Say you like a stock, but it has rallied past your buy point.  What to do?  Buy half.  If the stock comes back to the buy point, buy a full position.  If it rallies further, sell the position.

4) Same as number 3, but reversed for shorting.

I would almost always scale in and out of positions as an institutional investor, rather than doing it all at once.  I credit Jim Cramer for teaching me this.  The real Jim Cramer is not the “lightning round, ” but the guy who scales in and scales out.  The lightning round is binary — buy/sell.  The real world is more nuanced — how much to buy and when?

But the real benefit of doing half is the psychology of the situation.  Many investors suffer from fear, greed, and regret.  Doing half short-circuits those responses.  When the stock price moves in favor of profits, be glad of those profits.  When the stock price moves against profits, reanalyze and either a) go flat, recognizing your mistake, and being grateful that it was small, or b) increase the bet to a full position, and be grateful that you didn’t put a full position on initially.

Scaling in and scaling out gives freedom to investors, and removing many of the psychological burdens that they bear.  It doesn’t mean there won’t be losses.  There will always be losses but they will be easier to bear, with no panic that leads to selling off at the lows, or buying at the highs.


  • tom brakke says:

    Right on both counts.

    I recently was trying to write a blog piece on incentives and was really struggling until I figured out I was trying to include too many different things. It turned into eight postings on misaligned incentives in different parts of the market.

    In making trades, you are right on the mark. When I was teaching students about the market, I’d remind them that when you sold a part of a long, you still were rooting for it to go to infinity (so you could keep selling profitable pieces of it) and if you were short you would still be hoping it went to zero (even though you had a smaller but perhaps better-sized position).

  • heywally says:

    “2) Say you want to buy a stock, but it is plunging like a stone. …”

    I totally agree with #2 in this piece – too many people apply the “don’t throw good money after bad” mantra incorrectly. Scaling in to weakness on oversold conditions (and taking profits as you also mention) can yield very good results if you know what you’re doing.

  • kapil says:

    Hi David,

    I have been using the scaling strategy during volatile times and I agree with you. I bought some stock at a low price and it got even cheaper. By the way, which broker would you recommend for trading corporates? I have not had much luck finding one.

    • For retail investors, I don’t know of any broker that does them well. I was an institutional bond manager when I managed corporates. I would try Fidelity, though, they are making a real effort there.

  • Very pertinent advice to many readers I’m sure. I know I always have and most likely always will scale in and out of positions. I refer to it as a ‘core’ position and a ‘trading’ position. You establish the core and then trade around until your full targets are hit in either direction.

    Works wonderfully and I’m glad more people are highlighting this, as too many ‘retail’ investors simply just plunk down a large amount of cash and buy everything at once.

    I guess one word of caution with this strategy/methodology though, is that it’s not for everyone. You’ve got to be able to take a more active approach in managing things or know enough to be able to set alerts and all that. Just wanted to point that out to the average retail investor who is usually much more passive.

    I would also argue that some hedge funds do this (I track hf portfolios on my blog). You can tell by their disclosed average costs or their SEC filings, investor letters etc, that they’ve scaled into a position over a couple quarters depending on where the stock trades. They’ll maintain a core medium sized position and trade in and out of bits and pieces of their holding.


  • Anonymous says:

    Absolutely, this strategy works well–except when you work for a portfolio manager who berates you for “lacking conviction.” I’ve been there.

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