Monday, June 4, 2007

Position Sizing and when to sell

Figuring out the right position size for a stock, and deciding when to sell and when to double down is probably one of the more difficult aspects of stock investing, and an area I find myself struggling with regularly. It is one of those areas of investing that I believe is a bit more of an art than a science.

Position Sizing
A lot of position sizing usually depends on an individual investors risk tolerance and desire for diversification. I know several people who keep a very concentrated portfolio (as few as 2-10 stocks), and others with upwards of 30-50 positions. Each has its benefits, though I personally lean towards the more concentrated portfolio, as it is easier to keep track of, and allows for more $$ in places where you have the most conviction. I personally like to fall within about 15-20 for the long side of my portfolio, as it allows for a bit more diversification while still allowing me to heavily weight my top 5 holdings, which I usually like to have about 40-50% of my total portfolio. I don't like to have a position grow to more than about 15% of my total portfolio, unless there is a very strong margin of safety or unless I am unusually confident in the companies prospects. In general, my largest holdings are ones I have the most confidence in, and those with the largest margin of safety (I will rarely, for example, invest 10% in a speculative stock). Many of my smaller positions (<3% positions) are in companies I would like to own more of but are a bit too expensive for me right now (examples would include MSII and PN). Others are ones that have a high potential payout (200%+), but also a decent chance of being worthless, and often include puts. I have recently considered adding a few puts of high flying growth stocks that I think are likely to face issues at some point (CROX, JDSA, RIMM, and JMBA), but that I would not want to short for fear of being wrong and losing my shirt. I would likely have these as 1% positions, unless I had a very clear catalyst and timing in mind.

Position sizing is a constantly evolving question. As information changes (the stock price, company prospects, etc.), the position should be re-evaluated to ensure exposure is consistent with the risk/reward of the stock. In the case of MCZ, I originally started it off at as a 10% position. When the halo deal was announced and the stock shot up, I continued to hold the position, as my fair value of its upside potential was now more than when I bought. When the stock reached $1.40, it was beginning to near some of my more conservative valuations. I asked myself if I would buy the stock again if I did not own shares, and the answer was yes--but it seemed to me more fitting of a 5% position in light of my other holdings, vs. the 15% holding it had become.

When to sell
I think this is another area that can be a bit more of an art than a science. With certain investments, I usually have a catalyst in mind that I plan to sell around--for example, strong earnings in a particular quarter. With others, I plan to hold the stock indefinitely as it is a company I want to be invested in over the long haul (EYE.A and CASH are good examples).

I try as best I can to stay objective with my holdings, and always ask myself if I would still buy if I did not own it--particularly after big moves in the stock price or news that alters my investment thesis. Madacy is a great example of an investment in which I lost my shirt, but I believe I played well, all considering. The stock got whacked down about 60% after what appeared to be a one-time issue with their largest customer. Management bought back shares, and I decided to double my position, as I believed my thesis was still intact. Over the next couple quarters, however, it became clear that this was more than a one time issue, and that the operating business was significantly impaired. I recently closed the position at a loss.

Most important, I think it is useful to continuing evaluate what strategy works best for you and what doesn't, and to make decisions accordingly. There are rarely hard and fast rules in investing, and I think this is an area in particular where that is true.


Trading Goddess said...

Yikes! A "Put" on my beloved CROX! Say it ain't so!


Research Intensive Investing said...

I love my $7 knock off CROX I got in Thailand, though the same ones made my friend's feet swollen. Go figure.

The stock has continued to defy gravity (and kudos who called the trend lasting as long as it has). I have been skeptical of how long this would last, but so far so good. I would not touch this as a short with unlimmited loss potential, but I think it may be worthwhile as a small put position to hedge out some market risk.