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.