Dow Theory: Buying in Scales

Reader J.P. asks:

“What is your recommendation for taking a position.  All in, or 1/2 in and average up or down. I can't find anything on this on the website.”

Our Response:

In answering this question, we’re going to cite the sources that are the basis for our investment approach.  First, we’re going to start with S.A. Nelson’s book The ABC of Stock Speculation which quotes the work of Charles H. Dow, co-founder of the Wall Street Journal.

“The main purpose of this study is to enable the trader to determine, first, the value of the stock he is in; whether it is increasing or decreasing and, second, when the time to buy seems opportune. Assuming the thirty day swing to be about 5 points, it is in the highest degree desirable not to buy when three of these points have passed, as such a purchase limits the probable profits to about two points.

It is therefore generally wise to look for a low point on a decline. Suppose, for instance, that Union Pacific was the stock under consideration; that it was clearly selling below its value, and that a bull market for the four-year period was under way. Assuming further that in a period of reaction Union Pacific had fallen four points from the previous highest. Assume earnings and prospects to be favorable and the outlook for the general market to be about normal.

“This would be the time to begin to buy Union Pacifics. The prudent trader, however, would take only part of his line. He would buy perhaps one-half of the stock he wanted and then give an order to buy the remainder as the price declined. The fall might go much further than he anticipated. It might be necessary to wait a long time for profit. There might even be developments which would make it wise to throw over the stock bought with the hope of replacing it materially lower.

“These, however, are all exceptions. In a majority of cases this method of choosing the time to buy, founded upon clear perception of value in the stock chosen and close observation of the market swings under way will enable an operator to secure stock at a time and at a price which will give fair profits on the investment (Nelson, Samuel. The ABC of Stock Speculation. 1902. page 37-38. [emphasis our own])”

The above piece summarizes almost all of what we’re hoping to accomplish at the New Low Observer. Our work attempts to address the following as summarized in the indicated source (Bishop, George.  Charles H. Dow and the Dow Theory. Appleton-Century-Croft. 1960. page 50.) :

  1. The approximate value of the stock in which he [or she] intends to trade.
  2. The tendency of the market-bull or bear.
  3. The relative position of the stock from the viewpoint of near term market action
  4. The approximate value of the stock “for some months to come.”

Keep in mind that “prudent traders” use the method outlined above.  Also, the concept of fair profits are critical to this strategy of investing.  We’ve outlined a play-by-play on how the seeking of fair profits works in our March 18, 2010 article titled “Gaining More by Limiting Our Gains” (found here). Be sure to follow up on the links in the article so that you can gain more insight on Dow’s concept of seeking fair profits.  At the time that we wrote that article, we normally sold the entire position that we took.  However, after seeing our recommendations to buy were at the extreme lows in the price and then rocket much higher after selling, we’ve converted to a policy of selling the principal or initial investment for the less speculative positions (i.e. dividend increasing and Nasdaq 100 stocks).

Finally, below is a small sampling of stocks that we’ve singled out that are of interest to us with our recommendation to buy in scales on the way down:

  • Just Energy on February 14, 2013 (found here): "If you’re interested in this stock, consideration of purchases of Just Energy should be entered into in three phases, once at $6.60, $6.00 and $4.00.  Naturally,  breaking below $6.00 on the downside suggests that the floor’s the limit."
  • AGF Management on October 26, 2012 (found here): "Although we suspect that AGF Management will decline to the prior low, funds dedicated to this stock should be done in three stages.  Once at the current level after appropriate due diligence, and again at the 2009 low.  The third portion should be allotted for any additional decline below the 2009 low."
  • Ritchie Brothers on August 17, 2012 (found here): "Cautious as we might be under normal circumstances, we believe that RBA is worth considering at the current price with another planned purchase if the stock declines to the $13.78 level."
  • Microsoft on January 24, 2013 (found here): "We recommend buying MSFT in two stages, once at the current price and a second time at or near the $20 level.  The stock should be considered for 10% of your portfolio on the first purchase and an additional 10%-15% for the second purchase.  Keep in mind that the outside possibility exists that MSFT could decline to the 2009 level."
  • Ross Stores on March 8, 2013 (found here): "We’d buy ROST in two stages, once at $52.50 and again at $40 using 7% of the portfolio for each purchase."
  • Baidu on April 26, 2013 (found here): "All indications, based on the SRL, are that Baidu is worth considering in a two stage purchase plan, once at the current level and again at $67 or lower."
  • Teva on May 24, 2013 (found here): "The strategy for taking advantage of the relative low in the price is to break the purchase of Teva into 2 or 3 stages.  In either scenario, buying now would be a reasonable reaction to the current price."
  • Maxim Intergrated on August 23, 2013 (found here): "The extreme downside target is $11.10, however, we don’t expected this to be achieved.  Potential investments at the current level along with stepped up amounts of capital at $19.03 and $15.87 is recommended."

We hope that this brief summary proves useful going forward.

*Coming September 23, 2013: Canadian Dividend Watch List

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