Do you buy or do you sell? Steve says the following:

Here’s the deal, if you felt Apple was a good buy at $130 and it drops to $120, why would you sell? Unless some really bad long term news came out, this is a buy trigger to me. Not only does it lower the cost basis of your original purchase, but it increases your holdings at a price better than you thought was good before.

That is a very dangerous game to play since if the stock drops again you now lost double the amount. And you cannot predict whether a stock will go up or down since it is a general crapshot. Easy come and easy go is quite common in the market.

Bottom line is, if you don’t need the money right now or in the next couple of years, there’s no need to panic when a pull back is coming because it’s really irrelevant in the big picture. The goal, at least in my opinion, is to amass shares of great companies and you need the market to drop to do that. Does Buffett dump Coke when it has a bad quarter? No, he doubles down. He knows he’s picked a great company and it will come back and when it does he’ll have a lot more shares that he bought with profits he got during the up period.

I am guessing by referencing Buffet you are talking about value investing, and buying and holding a stock. First let me repeat double down is a very dangerous game! My algorithmic trading system uses it, but unless you follow the market and watch how stocks are doing you will get your fingers burnt quite badly.

If you think you can double down and then hedge yourself with put’s be careful as I addressed this recently. Two days ago I looked at setting up a hedge with Apple, and calculated that it is too expensive and risky. Right now Apple is hovering at 45% implied volatility and that is absurd! This means to recoup your option premiums the stock has move at least 45%. With Apple being what it is that is a risky premium.

What I want to focus on is that pullbacks, and surprises are quite relevant, and let’s look at the Apple stock. Apple is flying high right now. But it was not always like that. Imagine you bought Apple in 1999, you would have had to wait until 2005 to recoup your profits. Imagine doubling down on Apple as the slide was going down? So for five years you are under water with your long shares. Can you afford to be under for five years? And what if you were leveraged? You could be wiped out. Ooops, many were after the dot com bubble.

To give you an illustration of how dangerous double down due to surprises, Steve Jobs himself did not even believe that Apple would do as well as it is doing now.

As of Friday, 5/25/07, Apple is trading for $112 per share. Therefore the value of the 10,000,000 shares assuming he still owned them all would be $1.12 billion.

However the value of the options would be far greater had he held them until now. The intrinsic value of the deeply in the money ESOs trading at 100 delta would be as follows: (112 – 9.15 x 15,000,000 = 1.54 billion) plus (112 – 21.80 x 40,000,000 = $3.6 billion) for a total of $5.14 billion.

So the exchange of the ESOs for the restricted cost Mr. Jobs over $4 billion. This is the most expensive and worst options trade ever made.

Steve Jobs the ultimate insider of Apple is a trading DUFUS! He is worth over a billion dollars, which is pretty good. But he gave up 4 billion because he wanted the security and safety of stocks. I don’t blame him, and I am not critiquing him. What this tells us is that Steve Jobs himself did not expect this kind of success. And if the CEO of the company did not expect this success how can a stock picker be smarter? Answer is that you can’t, and that successes like Apple often are a crapshot.

This means that timing is 100% relevant! I even think Buffet would not argue with that. Buy and Hold is a bad strategy, and I have data to back up what I say. Consider the following image.

This image is a profit (Y-axis) vs number of trades (X-axis) chart for a particular equity using a Monte Carlo simulation. I call it the tree structure and it is very telling.

  1. If you buy and hold, and the stock goes up, then you will make money.
  2. If you make some trades then probably you will loose money and it would appear that less trades is better.
  3. If you time the market then the chances of you making money in excess of buy and hold is pretty good.
  4. If you do bad trades, and think doing the opposite is the right thing to do, no, you are wrong because a bad trade is a bad trade.
  5. Sometimes a trader cannot hit the broad side of a barn!

This tree structure is consistent for ALL EQUITIES that I have tested against! What this told me is that if the equity is going up a buy and hold will yield a certain amount of money. If you trade a few trades then you will reduce your profitability. But if you increase your trades your profitability increases quite a bit because you are timing the market.

The net result is that a buy and hold will only earn about a third of day trading the same equity. The results vary since some equities go down, some go up, and so on. But there is always a timing to an equity.

For example a buy and hold of the equity modeled by the image would have yielded a 31% return. Respectable, yes. Yet had you day traded a buy side only, meaning no shorts on this equity you would have yielded a return of 90% with NO LEVERAGE.

Conclusion: Daytrading the buy side only of an equity that you believe is a winner yields more profit than a buy and hold strategy. Because you can’t predict the winners, day trading the equity you will at the worst not loose money. Double down works effectively in day trading scenarios because you are keeping a very close eye on your bottom line. Otherwise is a good way to wipe out your account.

I totally agree that buy and hold is a bad strategy, however I don’t buy and hold, I buy and take profit (AIM system really) so when I double down, I’m gaining more shares and as it bounces back I sell them off, taking my profits. I don’t tend to leave profits unless a stock (apple in this case) is running.

Anyone who buys stocks using leverage is asking for trouble, I only use cash and I don’t trade options, I don’t use puts and I don’t short. I only long name monopoly stocks.

To compare Apple back in the day to Apple today is, um, comparing apples to oranges really. Back in the day Apple didn’t have the iPod, Macbook, Macbook Pro, Mini, iPhone, AppleTV or the dominating iTunes Store. I wouldn’t invest in Apple back then (and didn’t.)

What it comes down to is you need to pick the right investments, which we both agree upon, and you need to buy when the timing is right and you need to watch the news for the companies you own. Everyone could see AOL was in trouble when Broadband came and it dropped from $125 to $10. If you held that, you were nuts. However, if you buy the drops on Coke and sell the profits and keep doing that, you can really speed up the compounding.

Good article, totally agree with your long-term concern, but short term (1-3 years) at least in my trading, doubling down (or just buying more shares on dips) has increased my profits greatly.

Invest in peace…

Steve: Let’s not call it doubling down. Let’s call it

>However, if you buy the drops on Coke and sell the profits and keep doing that, you can really speed up the compounding.

Using that terminology I would agree 100% with you.

My understanding of double down is that you don’t try to call bottoms, but just keep buying on the way down. My algorithmic trading system uses this and the double down flip. It essentially uses the logic that all stocks have bottoms and you can turn a loosing hand into a winning hand. It works, but not for the faint of heart.

Phil: I don’t day trade to those levels either. My algorithmic trading system does…

My findings: KISS… I kid you not.

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