Ideally, we would all have $100k+ in our trading account. That way we could allocate at least $10k into 10 different positions as I suggest in my eBook. Commissions would be a rounding error on trades of that size. Obviously though, that’s not realistic for everyone. We all have to start somewhere and scraping together even $10,000 to invest is no small feat and an accomplishment one should be proud of.
Unfortunately though, it’s very difficult to grow an account of that size. With 10 positions of $1,000 a piece, commissions become much more of an issue. For example, taking into account a single entry and exit at $9.99 a trade at TD Ameritrade, you would start out each trade 2% in the hole! If you stagger your entry or exit, a strategy I sometimes advocate, you will have to make even MORE, just to break even!
All that said, here are my recommendations for those trying to grow a small account:
Passive Investment via VTI
Passive investing is not something we generally advocate here at DIY Investor. However, actively trading a small account is a great way to potentially have commissions and small losses grind the size of your account down to a nub. This is a case where it MAY be appropriate to consider putting that money into a low cost ETF that provides exposure to the ENTIRE US stock market. For this approach, I recommend the Vanguard Total Stock Market ETF (VTI) that sports a rock bottom fee of only 0.05%. Further, you could look to add to this position anytime the stock market sags. Obviously, this tactic is not without risk. You could happen to buy in at a multi-year stock market top and be forced to extend your hold time out for years or even DECADES just to be made whole. That said, the US stock market has an uninterrupted history of rising over the long haul and the ~2% annual dividend yield will help smooth out the bumps to some extent.
Reduce the number of positions and focus on ETFs
Instead of having 10 positions of $1k each in a $10k account, you could look at dividing the account into 4 positions of $2,500 each with at least 3 of these positions invested in ETFs (or cash). To state the obvious, stocks are risky; especially the high valuation, growth stocks that I prefer. Any of these companies can unexpectedly preannounce lowered earnings or growth guidance, announce a secondary offering, or have a scandal involving upper management come to light. In any of these types of situations, you could easily be facing a double-digit gap down overnight. With 10+ positions, a single blowup won’t have an outsized impact on your account the way it would if you only hold a few positions. One way to mitigate this risk, is to shun concentrated exposure in a single stock in favor of an ETF. ETFs provide instant diversification. They aren’t likely to fall apart the way an individual stock can. The flipside though is that ETFs generally won’t have the explosive upside potential of a growth stock. For example, with an ETF you’re not likely to see a near 15% gain in two weeks like we are with OCLR, our 821x model trade. But again, never forget that your primary job as a DIY Investor is to manage risk. Throwing caution to the wind because you let greed get the best of you is a fantastic way to blow up your account!
Add margin to double your purchasing power
If you know how grow to your investment account, it follows that the more money you have to invest, the more money you will make. Multi-millionaires from Warren Buffet to Donald Trump understand this and are therefore not shy about leveraging debt to compound their wealth at an accelerated pace. We can employ this very same tactic by adding margin to our trading account. With margin, the cash and securities in your account amount to a 50% down payment on a line of credit provided by the brokerage; effectively doubling your purchasing power. It should go without saying that while margin allows you to grow your account balance twice as fast, it can also destroy your investment capital at double speed as well. Use margin responsibly, if at all.
That said, if you are disciplined, I believe deploying margin is an excellent strategy for growing a small account. You can use it to increase your position size and/or add more positions. If you would like to pursue this tactic, one online broker stands head and shoulders above the rest; Interactive Brokers (IB). As I write this, an IB margin loan rate on an account size of less than $25,000 is 1.91% compared to TD Ameritrade’s 8.75%. Furthermore, the commissions are also significantly lower, provided you’re not completely inactive.
I used to have five trading accounts at five different brokers. Now, not counting my IRA, I basically ONLY use Interactive Brokers. Only you can decide if it’s appropriate to use margin in your account, but it is nice to have the option available. Whatever you do, never forget: USE MARGIN RESPONSIBLY!
After a year long consolidation, the market has broken out to new highs. As I’ve mentioned before, we have to take seriously the possibility that the post Brexit shakeout ushered in a new bull market (or a resumption of the bull market that started in 2009 depending on how you look at it). A bumpy ride higher, north of 2,400 in the S&P 5000, seems quite reasonable.
So how do we ride this potential bull? Sure we can buy an ETF that tracks the S&P 500 like SPY, but that would only yield average results. To generate alpha we need to actively put together and manage a basket of above average stocks that will outperform passive index funds.
One of the most common questions I get is, “What stocks should I buy?” Well, no matter how much I believe in a company I would NEVER put a blanket buy recommendation on ANY stock. I only want to buy a stock when it looks like it’s ready for an IMMEDIATE move higher and there is a stop loss level close by to limit risk. I call the system I use help me identify these optimal entry points 821x.
When I want to add a new position to my portfolio, I scan HUNDREDS of charts looking for 821x buy signals and only enter the very best looking setups. Some of the watchlists I scan through are from paid services and others I have built myself. However, I am going to share with you two of my favorite watchlists that are completely FREE. Both of these lists are focused on companies that are expected to experience above average earnings growth, which is a great place to put our money in a bull market environment.
IBD 50 – you have to subscribe to Investors Business Daily to gain access to the most up-to-date IBD 50, however, you can get a decent idea of what’s on the list for free by checking the holdings of the FFTY ETF.
Riding these stocks is actually a lot like riding a real bull. You are likely to take plenty of bumps and bruises along the way when a trade doesn’t play out the way you hoped it would. You’ll also likely experience the frustration of getting “bucked off” a big winner before it makes it’s run like we did in OMN and we almost did in NTG. If it was easy, then everyone would be doing it. However, if you do your homework and follow your trading system, you’ll come out of this bull run with a lot more money than you had beforehand.
The S&P 500 closed at a new all-time high yesterday. Upon hearing that, the average investor’s first instinct is to think that the market is topping out. Stocks are too expensive. Valuations are dangerously stretched. The higher they fly, the harder they fall. We are overdue for a crash etc., etc..
However, we here at DIY Investor know better. Perma-bear fearmongering is as unhelpful as unchecked bullish exuberance is dangerous. Emotions and feelings aside, here are the facts: after making it’s FIRST new intraday high in over a year on July 11th, the S&P 500 made 8 additional new highs and there is no reason to think that there aren’t several more on the way. Only ONE of these new highs will be a long-term top. MOST of them are just stepping stones to higher and higher prices. That’s why, counterintuitively, new highs are bullish.
If this rally continues, fears of a failed breakout will give way to a fear of missing out. IF this happens, the market can enter a mania phase where the uptrend gains EVEN MORE momentum. IF the last remnants of fear give way to unbridled greed, the market can explode into full-on bubble territory, which would mean we would see MUCH higher prices than we are seeing now. When this hypothetical bubble inevitably bursts, it will end badly for those that are unprepared. However, those of us with a plan will do very well and be able to lock in the lion’s share of our increased wealth.
Before you accuse me of smoking something, let me just say that I fully understand that this is a far-fetched potential scenario. Nevertheless, I do believe it is one worth keeping in the back of our minds as we break out of a year consolidation to new highs.
P. S., I only provide the actual buy and sell instructions for our 821x model trade here on the blog and through email to subscribers. Be sure to follow me on Twitter @marketchameleon for updates in between. On Tuesday, we received an 821x sell signal on NTG, our model trade. However, I recommended via Twitter that we not close the position unless it closed below $18.10. The stock pivoted and proceeded to put in an 821x buy signal on Thursday so far averting an unnecessary shakeout!
— David White (@marketchameleon) August 3, 2016
“Turn that off, it’s time to go to sleep”, my wife said. But I couldn’t pull my eyes away from my phone. The market that had closed the regular trading session just shy of all time highs a few hours earlier, was now plummeting faster than I had ever witnessed before. The “expert” consensus was wrong. The majority of British voters wanted to leave the European Union.
The “Brexit” whipsaw underscores the importance of staying flexible. A bearish macro pattern of lower highs and lower lows that had controlled the weekly chart of the S&P 500 for most of the last year was broken a couple of weeks before the Brexit vote. Bullish! The post Brexit crash sliced through TWO potential higher lows AND the 200 day moving average. Bearish! The snapback rally that followed reclaimed ALL of the moving averages in just 3 days. Bullish! I don’t think I ever flipped my stance back and forth from bullish to bearish faster.
A few weeks on, with the S&P 500 now at all time highs, it’s easy to say that the Brexit whipsaw was just a bunch of noise that was best ignored. Keep in mind though that one of these days we may see the beginnings of a REAL crash. Never forget that complacency can quickly wipe out all of your hard earned gains and then some.
So where does the market have the potential to go now? The S&P 500 has just carved out an ENORMOUS bullish “W” formation visible on the weekly chart. As I mentioned before when discussing the two smaller W’s that make up the bottoms of this larger W formation, the potential measured move is calculated by adding the height of the W to it’s top. I calculated a conservative height that ignores the “tails” of the weekly candlesticks as well as a more aggressive target which includes the full height to draw in the rectangular “measured move zone” in the chart below.
As you can see, a move to the potential measured move zone is good for better than 220 points or 10% over the next year! As long as the S&P 500 continues making higher highs and higher lows above it’s moving averages we will maintain a bullish stance… but as always, stay flexible.
“News” that George Soros is shorting stocks grabbed headlines once again this week. I don’t see why this is getting people so worked up. Soros has supposedly been making big bearish bets since the beginning of the year. He’s been warning of a repeat of the 2008 financial crisis and apparently has a 2.1 million share put option against the S&P 500.
I have no clue if George Soros is right. However, I do know that “news” like this does nothing to help us make money. We make money when we position our trades in the direction of the 8 and 21 day moving averages. Right now these moving averages are rising, so we are bullish and long stocks. In fact, this week the S&P 500 poked through the highs of last November, essentially negating the macro pattern of lower highs and lower lows that has controlled the big picture over the last year.
The only argument bears can make now is that this was a failed breakout which will lead to a fast drop lower.
I will grant that this is a possible scenario. However, the weight of the evidence we have right now still points to higher prices.
If Mr. Soros and the bears turn out to be right, we will have plenty of time to change our stance and position our portfolios accordingly. We would lock in profits and raise cash as our holdings give us 821x sell signals one by one. We could look to move some money into other asset classes such as bonds and/or gold. Finally, we may take bearish bets against stocks alongside Soros by purchasing inverse ETFs,
We will have sufficient early warning.
We have a plan of action.
There is no reason to fear.
A dangerous misconception many DIY Investors have is that our job day-to-day is to “make money”. Obviously, that is the outcome we are hoping to achieve, but it is not what we actually do. Remember, we have no control over the direction of the market or of our holdings at any point in time.
No, our primary job is to manage risk. Day in, day out this is what we are actually doing. The stock market can provide life changing monetary rewards, but with those rewards come enormous risks. The only way to safely gain exposure to the rewards of trading is to strictly define and manage the risk you are taking.
There are two primary ways we do this:
Our position sizing tool combines these concepts. I encourage you to play around with it so you can get a good handle on how much you are risking on any given trade.
There is, however, another often overlooked component of risk management that is perhaps even MORE important than the ones above: patience.
By this I mean having the discipline to allow marginal or higher risk trade ideas go without you while patiently waiting for the BEST, low risk, high probability setups.
Warren Buffett has a famous quote that’s relevant: “The stock market is a no-called-strike game. You don’t have to swing at everything — you can wait for your pitch.”
The fact is, every time we enter a trade we are putting our money at risk. Therefore, we should always take a moment beforehand to ask ourselves, “is the perceived reward worth the risk?” Be picky. Be patient. I promise you, it will pay off.
This concept comes to mind when looking at a chart of the S&P 500. The market has just run 15% higher in about two months. It’s just below a declining trend line that connects the closing highs from last July and November.
If the current rate of ascent continues, we could be looking at new all-time highs in just a few weeks! However, what is most likely to happen? Personally, I think that after such a big run and at an important trend line, it’s more likely that the market will pull back in this area. This doesn’t necessarily mean that we should get short. The market doesn’t HAVE to pull back. And if it does, keep in mind that it would actually be bullish for the market to put in a definitive higher low before breaking the macro pattern of lower highs and lower lows.
The bottom line is we have a short term bullish market still within a larger bearish look. These mixed messages are about to come to a head so I believe the best course of action right now is patience. It makes no sense to increase exposure to risk in the face of this uncertainty by taking big bets here. Let’s continue to manage our open positions and patiently observe market action in this pivotal area. There will be plenty of time to pounce when the outlook becomes clearer.
Stubbornly defending what you believe to be right in the face of harsh opposition is an admirable quality. It takes strong inner fortitude to enable someone to not be swayed to and fro by the opinions of others.
As admirable as this quality can be when dealing with others, it is possibly one of the WORST traits you can have when dealing with the market. Allow me to explain.
No matter how smart you are or how much research you do, there is no way to be right 100% of the time. The only reason you buy a stock is because you believe it will increase in value. However, before you put one penny at risk make sure you know where you will cut your losses. If your trade gives you your predetermined sell signal, have the humility to admit you were wrong. Don’t be stubborn. Don’t rationalize. Don’t hold and hope. Hit the eject button and sell. Yes it sucks to book losses, but it’s not worth the risk to continue to hold. If the stock is any good it will setup again and give you another buy signal down the road. If not, you can watch it implode from the sidelines.
It makes sense and sounds easy to do when talking in the abstract, but the fact is, even billionaire hedge fund managers can be prone to stubbornly digging in their heels when they have a trade going against them . Case in point: Bill Ackman of Pershing Square Capital Management and his dogged determination in defending one of it’s top holdings, Valeant Pharmaceuticals (VRX).
In fairness, being a “contrarian” has always been a part of Ackman’s shtick and he IS a billionaire, but wow, from a distance this looks like pig-headed obstinance on a grand scale. When VRX got cut in half from August to October 2015 Ackman doubled down and increased his stake. Then, earlier this year when VRX was hovering around $90, he added to his position again! Now after another bloody week. VRX has just one tenth of the value it had seven months ago.
I know that there are many different ways to make money in the market, but WE NEVER ADD TO LOSING TRADES in the 821x system. We take our loss and move on. Why would we want to tie up fresh money in a down trending stock?
As Bill Ackman can attest, stubbornness when trading can be quite expensive.