Hey it’s Sasha Evdakov and welcome to Tradersfly.com where I share with you some interesting insight as well as some educational lessons about the stock market investing and in your money.
This week's lesson is all about some words of wisdom from some of the great investors and traders and that is to Scale in and buy stocks as they move up not as they move down in price. Before we even get into evaluating and analyzing what some of the great traders and investors said about scaling let's understand what is scaling and why it's somewhat important to understand.
Basically you can do scaling in in two different ways so as a stock is heading higher you may not want to put your full position on right away because you don't know if it's going to continue moving higher so what you could do is you could go ahead and purchase some shares and as that stock continues to move higher you can purchase a few more shares.
Now again as we continue to move higher price you can continue to scale in more and more share so for example if you started with 10 shares initially you can continue adding 10 and 10 and 10 more shares up until you reach your desired share quantity which may be a hundred now this methodology it works out pretty well because the stock is moving higher and you're continually staying in profits.
On the flip side some people like to scale in as the stock is heading lower so for example as the stock is moving lower you may purchase again let's say 10 shares that it continues to move lower you continue to purchase more shares and so forth so you continue purchasing ten shares as that stock heads lower until you reach your desired quantity of let's say 100 share.
The problem with this or kind of the issue with this is now you're purchasing stock and you're losing your position in terms of profitability on the flip side the advantages to this and what people really hope to achieve and gain from scaling in on the downward trend is that they hope that that stock will continue to move higher and balance at some point because they're trying to catch it at a lower price so they're hoping to get it at a bargain in hopes of the future working out into their favor that way they can get it at a nice average price.
If we look at what some of the great investors and traders have said about scaling over the years here's what Jesse Livermore said in the book Reminiscences of a Stock Operator by Edwin Lefevre, “I must buy on a rising scale. I don't buy long stocks on a scale down i buy on a scale up”.
Now Arthur Huprich sometimes known as Art Huprich of Raymond James said “Don't average trading losses, meaning don't put “good” money after “bad”. A dding to a losing position will lead to ruin.” So in the end what are these great traders and investors are telling us what they're telling us is that you shouldn't continue to put bad money into a bad stock.
That's like continuing to pour more and more money in a fixer-upper. The better approach is to actually continue to put money into a stock that continues to reward your continues to appreciate in value over time.
Let's take a look at some different stock charts and see how these concepts apply regarding scaling in the real world scenario or how they would have played out over time.
Here's an example of Autozone, symbol AZO. You can see that this stock continues to appreciate and now it's currently in the seven hundreds. Now the stock price was just twenty and thirty dollars per share in the nineteen nineties and if you would have purchased a thousand shares during that time you would have cost you around $30,000 to purchase that stock currently the stock price is around seven hundred and forty dollars.
Let's just say $700 in order to reduce some of that investment capital of $30,000 to make number simple so on your thousand shares that you invested you would be up or profitable of over $700,000 know if you only invested $15,000 let's just say you didn't have $30,000 you still would have been ahead by three hundred and fifty thousand dollars now on the flip side if you would have doubled your investment and invested $60,000 or two thousand shares of stock in the nineteen nineties right around that $25 mark you would be up about 1.4 million dollars today.
Let's take a look at this example of Priceline. Priceline in 2009 with around $100 a share and now it's $1200 a share. This stock continues to move up higher and higher even if you didn't purchase a thousand shares right away you might have started out with ten shares then you might have purchased another 20 shares as the stock continues moving higher then again you could have purchased another 20 or 30 shares.
Over time you could have got a hundred shares 500 shares or a thousand shares and continue to stay in profitability.
This stock again would have continued to make you money time and time again as that stock continued to move up to higher prices as you can see scaling into Priceline over time even if you didn't have a ton of money to invest would have kept you in profitability and the same thing with Autozone because you're scaling in on a step-by-step basis.
If we take a look at MasterCard the same concept applies it was $20 in 2008. Now it's currently in the nineties but it did have a 1041 split in 2014 putting that stock price roughly at $900 if you got in it earlier.
If you're looking to scale into a position because maybe you don't have the financial means to get into a stock fully right away scaling into stocks that continue to reward your overtime is a much better play rather than scaling into losing positions in hopes of sometime in the future those stocks catching a bounce or getting back up to those higher prices and that's what most people think is that if they purchase a stock that used to be high-priced that it potentially could reach those high prices again sometime in the future and that's why they’ll purchase it on the way down.
If we take a look and evaluate at First Solar which you could have done on a scaling down position you can see that the stock was in the two fifties and in the two hundreds. Now currently the stock is in the forties and in the 50 region but so far over multiple years this stock still hasn't gotten back up to those two hundred and that 250 dollar region.
Can you imagine those people that purchase that stock First Solar right at those highs still waiting and hoping to get out? Now for that stock to get to those two hundred and two $50 region it nearly has to quadruple go four times the value just so those people can break even without a loss.
Here's an interesting example of AIG which was once at two thousand dollars a share and then in 2009 as you probably remember we had that collapse of the market and now it's under a hundred bucks. So think of it this way if you were scaling into this position as that stock is heading lower can you imagine how high you have to now wait for that stock to go until you're just breaking even.
Imagine all those losses that you would have incurred or would still be holding onto hoping and praying for that stock to just get back to those higher prices and that's what happens with a lot of these companies that sell off from higher prices is that any time they get a bounce there's just so much overhead supply so many people waiting just waiting and hoping to get out at a higher price so their losses aren’t as big.
Here's another example that I love to use so AMD sold off from the forties in the year 2000. It had some potential in 2006 which allowed you to get out if you were scaling into that losing position but again we had a selloff and have been under that $10 mark since 2009.
So if you think about your investments or the time value of money holding on to that position in the thirties you nearly have to be waiting for that stock to triple or three times as high just to be breaking even and right now since that stock is under 2 and 3 dollars you pretty much have to have it explode to the upside for you to just break even.
Looking at these charts and somewhat case studies you can see that I gave you somewhat of a more favorable position or somewhat favorable view to looking at charts that are more beneficial to purchasing stocks to the upside or stocks that are moving higher. That's usually where you want to scale in. If you did do it on the flip side and did manage to successfully scale in into a losing position and then eventually that stock popped usually those times are rare and few.
The primary problem with scaling in on a losing position or a stock that's moving lower is that you can really get stuck in that price region or price bracket where that stock never breaks out and now for ten or twenty years you may be holding that stock and it never gets back to even and you're holding out for a loss imagine all the other trade that you could have done or all the other investments that you could have done with that revenue or that capital.
Now if you are scaling in and the stock is moving lower you want to scale in as that stock is pulling back lightly rather than a stock having a major selloff and in which case I may say that yes go ahead and you can scale in because it's having a minor slight little pullback but if you're looking at the long-term picture and you see on the long-term picture that stock is pulling back heavily that is not the time to start scaling in and averaging your position.
I have seen some financial advisers and some financial articles written saying that yeah "do you think that you know big companies are going to go out of business or very stable companies in the make a justification and pick a name regarding a certain company but I can think of a few companies in a few different instances where even though they had a very stable company very solid stock movement eventually still did collapse got delisted off the stock market or still are a hanging at those low prices.
The problem with scaling in on it a major losing stock or stock that's really heading lower is that you can get stuck into a position and then that stock never breaks out and you're holding on to those losses for many years so remember what some of the greats along with Jesse Livermore said is that “ I must buy on a rising scale. I don't buy long stocks on a scale down i buy on a scale up.
Thanks for watching this video hope you found it helpful and insightful.