Here's how you successfully pyramid into those types of situations:
Let’s assume we have a $100,000 portfolio and we are risking no more than $5,000 (5%) on any one trade.
Let's take a fictional 2,500 share investment from that old stalwart ABC Company, bought at $20. Let’s say it's now trading firmly above $23, and in order to maintain a $5,000 maximum risk, we up our stop loss to $21.
We want to continue to keep our maximum out-of-pocket loss at no more than $5,000, so in this case, we can purchase an additional 3,750 shares on margin at $23 per share for a total position size of 6,250 shares at a cost basis of $21.80 ($68,125 on 50% margin).
Now if things go against us and the stock trades to $21, we've lost $7,500 on the 3,750 shares we bought at $23, but we've made $2,500 on the 2,500 shares we bought at $20, leaving us with a very manageable loss of only $5,000 against our principal.
Forget about the lost paper profits on the first 2,500 shares that we bought at $20. It's our principal protection that we care about. Profits will take care of themselves if you do a good job minding your principal.
As long as things keep going right in the stock, you can keep right ahead pyramiding into the position using your growing equity to finance greater margin trades, while all the while limiting your risk to no more than $5,000.
So if the stock now moves to $28, and you've moved your stop loss up to $25, you can comfortably pick up an additional 1,650 shares at $28. If you get stopped out at $25, you lost 3 points on the new lot of 1,650 shares you just bought ($4,950), but you made $7,500 on the 3,750 shares you purchased at $23, plus an additional $12,500 on the first lot of 2,500 shares you bought at $20, for a total gain of $20,000.
Maybe that sounds a bit confusing at first. Read through it again … maybe a few times … and it will start to become clear.
Take a look at the 5-year chart on Dade Behring Hldgs Inc, (symbol DADE), and you will see just how simple it can be with the right stock to leverage $100,000 into a multi-million dollar portfolio with very little risk to principal.
Just remember, as your equity grows so can your position size, but never let your losses on any one position run greater than 5% of your total investment capital.
P.S. – Now that you’ve learned how to keep your losses small, and how to let your winners run. |
