In the 'Comments' section, an interesting query has been posted by Abhay pertaining to the likely hurdles in following the Strategy for Investment at different levels.
In the query, Abhay has registered some sort of apprehension on the use of strategy and consequently missing any upside momentum as stock prices keep moving upward. Though, he has not expressed this in writing, he is somewhat confused as to what should be done in scenarios when stock prices keep on moving higher on every bout of selling that an investor/trader uses by way of strategy.
The feeling could be roughly described as below:
(A) I sold some quantity of stock at Rs.X, but later the stock price went up to Rs.X+1.
(B) I again sold some quantity at Rs.X+1, yet again after I sold the stock price went up to X+2.
(C) Now, if I continue to sell some more at Rs.X+2, what if the stock rises to X+3?
(D) Hey, You never know... the stock may ultimately top out at an exuberant X+5 levels. If so, why should I sell now?
(E) In the meanwhile, what is Market Crashes down in near future?
I had L&T at Rs.950/- I sold my 30% of L&T at Rs.1400/- after 2 days.
It rose to Rs.1650/- What should have I done, sell again or what? Strategy for investment plan is great... but it does have some limits. Can u please suggest the readers and me a better strategy, if any? I have short-term perspective on L&T.
In this posting, I shall try to address the above query in detail regarding how to use the strategy for Buying or Selling more fruitfully to avoid any 'Missed-out' Feeling. Whether we can use some other strategy? The posting seems to be a bit long, but i shall try to keep it as simple as possible:
The Pyramid Concept:
Lets take an example of a ‘Pyramid’. It is typically tapered at the top and it gradually broadens with more space as we go down towards its base. It consumes the broadest space at the base and most narrow at the top.
Let me come directly to the query of Abhay in specific relation to his trade in L&T which he had bought at Rs.950/- for Trading purpose.
1) Abhay has bought L&T @Rs.950/- (Let us assume he has bought 20 shares with an investment of Rs.19000/-)
2) Since he has bought this Infrastructure and Capital Goods stock just in time before an all-important event of Budget announcement, we will likewise strategize the trade keeping that in mind. So, we can factor in that the stock shall make bigger moves before the budget as the stock is placed at the sweetest spot to benefit from government’s emphasis on Infrastructure spending and development.
3) We will first create a strategy to sell the stock at specific intervals or at specific price points. Like, for example, the selling should be in small quantity at profits in initial stage. However, the selling should gain more aggressiveness as the stock rallies higher and we move closer to the base of ‘Pyramid’. And, at last stage of excessive euphoria, our selling should reach peak levels (at the bottom of the pyramid) when others are buying aggressively.
4) So, going by above planning schedule, we will strategize to book profits in L&T in 3-4 phases at different price points. The selling would be done in such a manner that Abhay should benefit more with every rally even after selling at lower levels but still at profits.
First we would sell 20% (20% of 20 shares = 4 shares) of the stock at Rs.1200/-. Amount redeemed Rs.4800/- with a profit of Rs.1000 accrued on 4 shares bought at Rs.950/- and sold at Rs.1200/-.
Second we would sell a large chunk of 30% (30% of 20 shares = 6 shares) of L&T at Rs.1450/- assuming that the stock has already appreciated a whooping 50% from Abhay’s cost of Rs.950/-. Amount redeemed Rs.8700/- with a profit of Rs.3000/- on 6 shares bought at Rs.950/- and sold at Rs.1450/-. We have got rid of 50% of the stock held until this phase- 20% in Phase 1 and 30% in Phase 2.
Now, to the surprise of everybody the stock appreciated to Rs.1650/- in a matter of few weeks. No problems, we will sell another major 30% (30% of 20 shares = 6 shares) of our L&T scrip at Rs.1650/-. Amount redeemed Rs.9900/- with a profit of Rs.4200/- on 6 shares bought at Rs.950/- and sold at Rs.1650/-. At the end of this phase, we have almost sold-off all our stocks with barely 20% of the stock still left to be sold. But, herein lies the caveat. One should not under-estimate the ability of return generation from these left-out 20% stock, if they're sold at higher prices. The reason being, these remaining 20% would be sold at the 'BASE' of the Pyramid, which would yield attractive returns even from a small quantity.
Now, we are skeptical whether the stock will move to Rs.1850/- or not since the stock has almost doubled from Abhay’s cost price in a compressed time horizon. Still we are left with a crucial 20% (20% of 20 shares = 4 shares) of the lot which Abhay had originally bought at Rs.950/-. Lets suppose that L&T moves to Rs.1850/- we will sell all the remaining 4 shares at this price. If this price does not come true, Abhay will have to maintain a Trailing Stop Loss of Rs.1650/- on the breach of which he has to sell all the remaining 4 shares. In fact, he can as well observe a Deep Trailing Stop Loss of Rs.1450/- if he is a high risk trader (in case he can bear some risk of holding the stock to once again test his luck for Rs.1850 sort of levels). We will presume that Rs.1850/- levels did not turned up and Abhay sold the remaining stock at Rs.1650/- as per our Trailing Stop Loss Strategy.
5) The Rising Pie: If you notice in above 4 phases, the profits have gone up in increasing order of value. Abhay managed to sell 50% of the stock in Phase 1 and 2 with substantial profits of Rs.4200/-. However, the same amount of profit of Rs.4200/- also got accrued from Phase 3 itself, indicating that a larger share of profits is garnered as we move up the value chain of the Phase wise strategy following.
6) If you go back and visit the phase wise selling as described above, one would notice that we sold the first chunk of 50% shares at a healthy average of Rs.1350/- and the remaining 50% sold at Rs.1650/-. The average of all shares sold comes to Rs.1500/- which is still 50% higher from Abhay’s buying cost. Once can argue, that the returns would have been 100% if Abhay would have sold all his stocks at Rs.1850/-, but is it possible to time your exit at the highs as per one's wish. It is almost impossible to time exit at the peaks even for the best of the best Analysts or Fund Managers.
7) Stock Reversal: One another scenario would be, suppose what if the stock stops its upward journey at Rs.1450/- and does not test higher levels from there? During such time, Abhay would have already sold 50% of the stock based on guidelines in Phase 1 and 2 as mentioned above. But, for the remaining 50% of the stock held, Abhay will have to maintain a Trailing Stop Loss based on Technical levels which could be around Rs.1200/- or Rs.1300/- as the case may be depending upon stock to stock.
8) Now, suppose the stock reverses after testing the Trailing stop loss levels of Abhay, than again, based on Technical levels Abhay (as a trader) shall re-enter the same counter by buying the stock on an upward break-out above the previous highs of L&T at Rs.1450/- with a strict stop loss and a probable target of Rs.1650/-. Traders should always trade with the trend.
9) Where is the Opportunity? Suppose the stock tests Rs.1450/- and starts its decline for a long time to come. In such case scenario, if Abhay would not have booked even the 50% gains as mentioned in Phase 1 and 2, we would have felt terribly uncomfortable in selling at lower levels. At some point, even his cost of Rs.950/- would be tested in some vicious down cycle dragging all his profits to nil. At such times, use of Strategy (including stop loss strategy) would come in handy in aiding a trader from taking any emotional decision for his trades.
10) In the long run, use of strategy will help you in entering and exiting your desirable stocks in a swift and a gradual manner without hurting your preset targets and disallow your decisions to be dictated by emotion-led calls. Use of strategy would also mean that a trader does not get stuck into his trade at any specific levels and gets to benefit from all the up cycles and down cycles of the industry.
Using Strategy in Investment:
Taking the same case scenario of Abhay from a long-term Investor’s perspective. Abhay bought 20 shares of L&T at Rs.950/-. Now, in a short span of time Abhay stands to earn a smart profit of Rs.500 per share at Rs.1450/- on L&T. What should he do?
11) Although Abhay has invested with a time span of 5-10 years, if he wishes to makes use of his portfolio investment held in L&T as a ‘Passive Trade’- he can sell 30% of the his stocks invested in L&T at around Rs.1450 to Rs.1650/-. By this, he will ensure that he is able to book profits in 30% of the stock held. But even still, he has a major 70% of the stock still invested to gain from any future upside momentum in the counter.
12) Buying Back Lower: In longer-term, Abhay will definitely get an opportunity to buy this 30% chunk back at lower levels of say around Rs.1200 or say Rs.1100/- or say even Rs.900/-. At that time, he can buy back those 30% chunk on dips, which sums up to nothing but lower averaging of his over-all cost for owning the stock. More aggressive but Passive investors could as well sell 40-50% of the stock around Rs.1650/- where valuations are more expensive for the counter. They can as well buy back some qty around Rs.1400 followed by Rs.1200 and even Rs.1100, as the case may be.
The follow-up of this strategy does have some specific hurdles. But, these hurdles are not strong enough that investors/traders can willfully shun the use of this strategy. The benefits from the use of the strategy clearly out-weighs the hurdles from the follow-up of the same.
Its somewhat similar to SIP (Systematic Investment Plan) facility that one avails of while investing in Mutual funds- investing in small lots at regular time intervals irrespective of market levels in order to benefit and brace from market volatility. Strong and Constant Perseverance in using the strategy for longer times to come will prove that the strategy has more pronounced benefits than hurdles.
The strategy concentrates on the aspect that when you book profits you dont book only part-profits and ride the up side momentum with the remaining shares held. On the other side, in the down trend, it ensures that you buy only in small but handful quantity on every larger dips. It sees to it that you an benefit in averaging on any further down side as the down leg deepens. Most of all, it ensure that your RISK is cut on both sides in any market condition.