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Saturday, 18 July 2020

(Tradeview 2020) - “Principles of Investing - Rule 4 : "Scaling Entry When Buying Falling Stocks”

Dear fellow readers, 

Once again, these writings are just my humble highlights (not recommendation), feel free to have some intellectual discourse on this. You can reach me at :

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The share market is a really interesting place. Over the years, I have seen all kinds of characters from my interaction with people who are actively investing in equities. At the extreme end of the spectrum, I have seen very intelligent people making the most ridiculous investment decisions and the most inexperienced investor making the best investment decisions. Greed plays a very huge factor in clouding judgment and impairing the ability to think rationally. After all, the saying goes :

One of the most frequent questions received from my readers : “The share I bought recently, the price is falling. Should I cut loss or buy more?”

My reply will always be : “Why did you buy this share in the first place?”

I think this is the most basic question one have to ask themselves when investing in a particular stock. If you do not know why you buy the share or you have absolutely no sound justification to invest, you are as good as flying blind. Hence, why am I emphasising this now? Because this question will determine whether one should average down / buy more of the same stock where the price is falling. Buying a stock that is trending up is easy - you simply just chase. However, buying a falling stock is truly an art that is very hard to master. Have a look at the video by Peter Lynch below :

If you know the fundamental value of the stock you are buying, naturally you would not be fearful when the share price fall. You may even be excited for the opportunity to add more position. But how about if the share price starts falling below your cost and your paper losses grow? Would you buy more then? At what point is enough, enough? 

Taking the recent sell off last week of the Glove related sectors where the panic selling of Top Glove cause the entire Bursa Stock Exchange to hang & stop operations from 3.30pm onwards. This was akin to the stampede on Top Glove overwhelming the entire stock exchange. At closing Friday, Top Glove share price recovered from RM 19.60 to RM 22.98, Supermax recovered from RM 15 to RM 17.70, Kossan RM 11.96 to RM 13.50 and Hartalega RM 15.10 to RM 17.10. Many others was sold off and recovered strongly like UG Healthcare, Comfort amongst others. I wonder, how many benefited from the sell off vs the number who panic sell?

Hence, Rule 4 when I invest, “Scaling Entry When Buying Falling Stocks”. There are many methods adopted when buying stocks that are falling such as :

1. Dollar Cost Averaging  - is an investment strategy that evens out the fluctuations in the price of an investment purchased over time. It works by investing the same dollar amount in a security at regular intervals. Ex : Say we buy RM 1000 worth of Supermax shares at RM 5 (200 shares). When it moves down to RM 3, we also buy RM 1000 worth of shares but as the price has fallen, we can buy more shares (333 shares). Our average cost would now be 533 shares @ RM 3.75 = RM 2000

2. Average Down - is an investment strategy for stock accumulation where the investment made to bring down the initial investment cost by buying at lower price. There is no fixed amount to buy each time unlike Dollar Cost Averaging method. However, we would advocate placing entry at different support levels based on the charts. This method is widely used by contrarians (like ourselves) to buy when the share price is on a downtrend as the belief is the share price will eventually rebound.

3. 80:20 Pareto Rule - Many people know the Pareto rule as 80% effect comes from 20% of cause. Adopting this principle in share market investing would mean 80% of profit making stocks will come from 20% of total stocks listed in the Bursa KLCI stock exchange. In effect, there is 1100 stocks in Bursa KLCI Stock Exchange, if I can identify 20% of the good stocks, (220 companies), I will be able to do well in my investments. Alternative ways to improvise the method, when it comes to averaging down, I believe 80% of income will derive from the 20% that I average down only, hence I must be highly selective when I average down stocks. 

4. 30% Rule From Peak - Another widely used method in scaling entry is whereby one should average down at 30% level and another 30% from peak that level, the share price bound to rebound. Ex : The peak price of Topglove before the sell down was RM 25.16, the good level to average down is RM 17.60 and after that RM 12.32 where eventually the share price is bound to  rebound above your cost. This is provided nothing has changed fundamentally / structurally for the share.

Scaling Entry Examples : 

Back in March 2020 plunge, we had some existing position on hands such as DKSH, GCB , CCK and RCE Capital amongst others. When the sell off happened, we were affected too but we did have enough cash on hand to deploy into buying whacked down fundamental stocks in our portfolio mentioned above.

1. DKSH - Our initial entry price was RM 3.85, we then average down to RM 3.20, RM 1.95 and lastly RM 1.80 bringing our average cost to RM 2.10.

2. GCB - Our initial entry price was RM 2.63, we average down twice at RM 2.10 and RM 1.90 bringing our average cost to RM 2.30. 

3. CCK - Our initial entry was 53 sens, we averaged down to numerous times at the range of 35 sens bringing our final average cost to 45 sens.

4. RCE Capital - Our initial entry price was RM 1.63, we averaged down around RM 1.45 and RM 1.30 bringing our final average cost to RM 1.51  

These are amongst the many stocks we have invested in and held throughout the plunge where we used the selloff to average down. These stocks are also companies which we are familiar with whereby we have confidence with the management and owners of the company in weathering the storm. Coincidentally, these companies shareholders / directors also have been buying back to support the share price which was a good indicator for us to average down as well. 

Before you decide to buy a falling stock, it is important for you to have :

1. Sufficient cash holdings;

2. Understanding and knowledge of the company you are investing in;

3. Phase out your entry each time in different tranches instead of going “all in / show hand”;

4. There are no fundamental or structural changes to the companies’ financial situation (ex : no accounting fraud like Wirecard, London Biscuits or Hin Leong Trading),

 5. Potential recovery in sight for broader economic outlook

Do stay tune for my next write up, “Principles of Investing - Rule 5 :  "Be Cynical, Be Skeptical & Avoid Tips”


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