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Advantage of Trading Around a Core Stock Position

By Edited Jun 19, 2015 0 0

If you have ever paid attention to the value of stocks over a longer time frame, you will notice that they often trade up for a while then reverse course and trade down, back and forth ending up in the same place that they were months or years before. This phenomenon can be demonstrated time and again with many different stocks. This can be very frustrating for an investor who feels that the time watching the stock move up and down has been wasted. It is why some people feel that the concept of "buy and hold" is dead.

Most people, however, don't want to day trade stocks or move in and out of different stocks on a frequent basis. They don't really have the desire to follow their stocks that closely, nor do they wish to do the research necessary to move from stock to stock. For these types of investors, there may be an alternative. The concept of trading around a core stock position is relatively easy to understand and can actually improve investment results over the long term. Furthermore, there doesn't have to be a lot of work or effort involved, especially with the wide availability of online brokers and online stock trading.

If you have a business that you really like, have researched its stock extensively and feel that it will do well over the long term, you can enhance your investing results by selling some of your shares on a spike in price and buying them back when the price is down. You can even use the extra cash from selling the stock and purchase additional shares at the lower price adding to your total position over the years. The key is to always hold on to a core block of shares that you don't plan on selling until the business is no longer what you believe it should be. If that becomes the case, then it is necessary to sell your entire position in the stock and replace it in your portfolio.

As you get to know the trading patterns of the stock in your portfolio, you can begin to identify points of support and resistance. These points of support and resistance can be influenced by the institutions holding some of the more well known companies. Many stocks of large companies are owned by large mutual funds that adjust their positions slowly over time. Also many of the stocks of these large companies are part of indices that cannot be traded but must be held as part of the index.

Some of the larger companies that might fall into this category would include Wal-Mart (WMT), Microsoft (MSFT), Merck (MRK), Coca-Cola (KO), and other well known companies and brands. It is easy to look back at the stock charts over the last five years and find that the price of these stocks have essentially gone nowhere over that time frame. Had you bought the stock in 2004, you would not have any more money today. That can be a major problem with the "buy-and-hold" philosophy especially for someone saving for retirement.

Consider the example of Coca-Cola stock (KO) over the past decade. Coke is a well known brand that has world wide appeal and has been an icon of American business for over a century. You could have bought the stock at $55 per share in September 1999. At the close of the market today, ten years later, the stock was trading at $50.41. That is certainly not the way that an investor can get rich. At least the investor would have received dividends over that time.

But, what if that same investor had traded around his core holdings in KO stock over that same decade? What if after purchasing 1000 shares in September of 1999, our investor bought another 100 shares every time the price dropped by $5 and sold 100 shares every time the price rose by $5? This means that, after purchasing 1000 shares at a price of $55 per share, when the price dropped to $50 an additional 100 shares was purchased. Then when the stock rose to $55 again, those 100 shares were sold leaving the original 1000 shares intact while pocketing $500 profit.

Let's compare the results of buy-and-hold vs. trading around a core stock position. In the buy-and-hold scenario, the investor pays $55,000 for his shares and ends up one decade later with $50,400 plus whatever dividends were received. The actual value of the shares has declined.

When we compare that to the trading system with very simple rules, we find (trust me on this, I reviewed 10 years worth of charts) that KO crosses a 5-dollar increment 54 times over the 10 years. The range in prices was from $40 per share up to $65 per share. Following the system, the investor would have 1100 shares of stock at $50.40 as of today for a total value of $55,400 plus an additional $8,000 in cash not to mention the dividends. This investor actually made money on the shares by ending up with more shares plus had spare cash left over. Imagine the results if the investor had used that cash to purchase additional shares by selling 100 and buying back 110 at each step along the way. The results would have been phenomenal compared to buy-and-hold.

One can easily see the benefit of buying low and selling high taking a little bit of profit out of each transaction while remaining committed to the stock. The system was not even that complicated by simply involved a transaction that occurred at a set price point. There was no complicated reading of charts or day trading. There weren't any fancy formulas to calculate. The investor didn't even have to follow the stock that closely but could simply have placed good-til-cancel orders with an online stock broker. This might have taken all of five minutes to enter several orders. The investor could check in once a month or so to see what happened and make a few adjustments.

Such a technique would be perfect for a fairly low volatility stock that pays dividends and is being held in a retirement account. The enhanced investment return would be compounded over many, many years and the added income in retirement would be very welcome. Just a simple change to an investment philosophy such as buy-and-hold can have a major impact. This technique can also work with exchange traded funds or baskets of stocks. I hope this article has given you something to think about in regards to your investment philosophy.



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