Investors who want to spot “great buys” and bypass “trading traps” need to learn the art of averaging into a position, argues TheStreet’s James “Rev Shark” Deporre.
Writing in Real Money recently, Deporre noted that trading conditions are “getting ugly” and that loads of stocks are going bid-less and sliding into the abyss.
Some of those stocks will be great buys, but most small traders don’t know how to average into positions.
According to Deporre "There are two main reasons for this. The first is insufficient capital, and the second is impatience. Small traders will almost always average into weak stocks too fast and too big. When this happens, it sets the stage for emotional selling when the stock does not bounce as hoped. The thing that wipes out more traders than anything else is averaging into a down trending stock too aggressively and then having some significant bad news hit. That is what causes the biggest losses.
Deporre said he sees many stocks being beat up right now that should trade higher in a few months.
"A good example is the cannabis sector. It is easy to think that they can't drop much more since most of them had some great earnings reports, but there is just no way to know when the trend will shift or how much lower they will sink."
Starting out requires caution, Deporre says.
"The key to averaging into a stock in a downtrend is to start very small and to increase the incremental buying only after a stock starts to act better. If you wait for a small bounce before you start adding more, you will have a very clear stop-loss point if you want to reduce the positions."
When building a position in a poorly acting stock, a big key is taking a stop and then rebuying it, Deporre added. Don’t allow the position to grow too big, too soon. Reduce it and then rebuy it when things shift.
"Additionally, know that the goal is not to buy the bottom tick. The goal is to try to catch an uptrend trend. When you focus too hard on catching the exact low, it is easy to lose sight of the fact that the stock may continue to languish even if it is no longer going down."