January 26, 2011

“So, if you buy a basket of stocks with a percentage of your assets...”

There is a selection process to be made. You intend to build a portfolio for the long term, and therefore, your “basket” of stocks should be composed of your best candidates for long-term appreciation. Say you want to start with 50 stocks for your first cruising level; you assign initial weights to the 50 stocks in the order of your long-term estimates.

Not all stocks are created equal, and therefore, we should not treat them all the same. From your best selection - take your top ten - assign higher weights, bigger initial positions and higher trade basis which will result in higher capital requirement equations. Sum these up to find your total portfolio requirement.

“How large of a gain do you need before reinvesting profits?”

It depends on your degree of trade aggressiveness. The amount of leverage you want to apply. The level of conviction you assign to your picks, and your feedback reinforcement function. Equation 16 is the controlling equation for this. Your mission is to end up with the highest number of shares in the highest performers within your selection without knowing beforehand which stocks they may be.

“Assuming you get stopped out, what would be a trigger to re-enter a position in that stock?”

If you get stopped out, things are not looking good. Since at first you only had a small position, the real question should be: “should this stock stay in my preferred list”. If the answer is yes, then wait for a percentage rebound from the eventual bottom. Let the stock “prove” that it wants to go up before giving it your seal of approval. If the stop happens under $10, then start looking elsewhere. Stocks going under $10 tend to take years to get back over that mark. You are not in the dead money business and I am sure you can find a better use of your capital. So on low priced stocks, my recommendation is to accept the small loss and look elsewhere.

“Do you have profit targets or would you write calls against a position?”

You are in long for the long term. So, your preferred holding period should be the same as Mr. Buffett: forever. By all means, do write calls. It should be part of your total solution. And holding long term does not mean that you can not trade over existing positions.

“If your stock was "called" away, at what point would you look to re-establish a position.”

If called, your stock is doing well; then repurchase and sell a new higher strike call. Your objective has not changed; the stock is still on your preferred list and showing signs that it deserves to be there. They can call you as often as they want; it is all right with you. You reset your position each time with a higher strike. This should even increase your conviction in your estimate and long-term goals.

Building a portfolio is a multi-period multi-decision process where it is necessary to determine which stocks to trade, the entry points, the bet size, the duration of positions and the management of inventory levels. You can use a decision surrogate to determine for each stock the best course of action in relation to all others in your portfolio. By having controlling functions you determine what you want to get out of the market, and on your terms. You want to reward the market (by putting more money in it) when it rewards you first. And if you look closely at the capital requirement functions, you will notice that one of the requirements (or side effect) is that you are requesting the market to in the end pay for it all.

Created on ... January 26, 2011, © Guy R. Fleury. All rights reserved.