Control of Risk - CLNE HMSY NUS

I was asked this week if I thought the market was going to go up, I said I have no idea. My belief is that nobody knows and those pundits who say big gains by a certain date or big falls by a certain date are all blowing smoke. All I know is how the market is performing today and beyond the headlights I have no idea. The markets are rising and all the major indexes are above their 50 day moving average, that’s all we need to know. This suggests we continue buying until we see otherwise.

I have spoken about risk control by buying a stock with a 10% sell stop to control the risk. My unit size for the sake of explanation is $100 so the investor has $10 of risk. I have also said how subsequent purchases will take away any risk because the second purchase in this initial company will raise your stop to break even. Future purchases at higher prices must have the break even stop recalculated to a higher level. Please read back if you are confused by this quick explanation.

As well as building up bigger positions in a company the investor should also broaden his or her holdings out to other companies. Analogies I have used in the past are that we are planting seeds which grow into big oak trees but now we also need to plant a lot more of those seeds to broaden out…. so here we go.

Buy one company ($100 purchase) with $10 of risk since if we are stopped out we lose $10. When that company rises (say 10%) we move our stop up to break even, so no risk. Buy a second company and do the same again. If the market is strong hopefully both companies will move up 10%. So now you can afford to risk buying two new companies with a 10% stop and still have minimal risk if stopped about. Let’s assume you have four companies now and they all move up 10% in a strong market. That would be a $40 gain so now we can go out and place another four $100 investments with a 10% stop loss and not risk any money. No money is at risk because we have the $40 profit as a cushion and if all four new investments get stopped out then you have only lost the profit.

You can see how exponentially you are rapidly buying lots of stocks in the market (planting lots of seeds in your garden). You go from one company to two, then four, then eight, then sixteen etc and all you are risking is the profit. Of course you don’t want to stay at break even if the market turns down since at some point you will lose those profits built. Take a portion of your profits to make new investments.

Let’s review, in a rising market we can build our one position into a bigger position as discussed in previous blogs (please read back). However we can also broaden out our investments by taking positions in new companies. A third option when you are in profit is to increase the unit size, after all you are not risking your initial capital since you are only using your profits. I like analogies, so we can plant a seed in our garden and grow it to an oak tree. We can plant more seeds in our garden to broaden out. A third option when we make a bigger units size purchase so instead of planting more seeds we are planting saplings or small plants.

The market is an uptrend and any pullbacks create buying opportunities. For a long time earlier this year I was unable to mention company names since the market was not in an uptrend. The stocks below have all jumped up on volume recently and have good earnings. These companies can be considered in their quiet periods as they pull back on low volume. Remember don’t buy before earnings are announced and don’t buy if these companies have high volume down days.

CLNE - $21.26

HMSY - $52.04

NUS - $28.66