What a bloodbath! It was not pretty yesterday, and today should not be much fun either for many investors. A number of subscribers to my newsletter, Nails on the Numbers, have written in with questions about the market, my system and how the carnage may impact my trading philosophy. So let's get right down to it. Here are two questions I thought you might find helpful and interesting. Q: Great job on McDermott ( MDR - Get Report), which won on Friday. It was a nice win on such a tough weekend with the hurricane and everything. Do you think your strategy will continue to thrive in this type of market that we haven't seen anything like before? -- Joe, Clarksville, Ga.
A: Thanks for the note, Joe. Friday was a good day. I grabbed two big wins -- McDermott for $4,100 and Tesoro ( TSO) for $7,100. McDermott, which was in play for just 10 days, was especially satisfying because the pick dipped quite a bit after I selected it, and I got a lot of email from readers who were worried about it. However, I stayed cool and followed my system, averaging down three times after my initial pick to put myself in a better position to score. I got my bounce and a nice return. I picked Tesoro on June 13, and it took some time to come around, but I got my win and it was a sizable one. As for whether or not I believe my system will continue to win in tough markets, there is no question about it. My system is designed to make picks where I see value. Even in tough markets, there are stocks that are undervalued. And the beauty of my system is that it has a built-in plan to follow if a stock goes down -- and it doesn't involve running away with my tail between my legs.
My system calls for doing homework upfront to pick a fundamentally sound company that is undervalued at the moment. I purchase contracts at a price I believe to be attractive. If the pick falls to a certain level, I add to the position and lower my average purchase price. If it continues to fall, I add more. I ride down with the stock until it hits bottom. And because I set my sell price $1 above my average purchase price -- I have been lowering that average purchase price as the stock price declines -- I don't need to dig myself out of a huge hole to score a win. I only need a bounce in the stock. Yes, yesterday was bloody but that doesn't mean you can't be smart about your investments and pick your spots. I will still set my purchase orders at prices I find attractive. Oh, and just a side note: The S&P 500 closed at 1,352.99 on March 25, the day I made my first pick this season. On Friday, it closed at 1,251.70. In between that time, I have scored a boatload of wins. Q: I've been doing well with your system the past month or so since Isigned up. Here is my scenario question: I started with just $5,000, and have managed to grow it well, but it is not nearly enough to allow me to buy into all your picks, especially the more expensive ones. Would I be better off cutting the number of options I buy, say from 10 down to 5, in order to better diversify myself, or would I be better buying as much of one pick that I can afford and just sticking it out?
Specifically, with one pick I've got 30 contracts now, which pretty much taps me out. If I was to invest some additional money, should I continue to repurchase those contracts at lower amounts to lower my average, or should I use that additional money to buy contracts on another pick? -- Matt, Lafayette, La. A: Matt, I have gotten many questions similar to yours in the last couple of years that I have been writing for TheStreet.com. You have a couple of questions in here, so I will start at the top. Are you better off buying fewer than 10 contracts to diversify your holdings? Many of my readers do that. My system is scalable. Essentially, I aim for a $100 win for every contract I purchase. So, if I have 10 contracts, I aim for a $1,000 victory. If I have five contracts, I would shoot for a $500 victory, etc. Now, the only variable is the trading costs. If you go for lower wins, trading costs will eat up a larger percentage of those winnings. As to whether you put all your money into one pick or less money into several, that's a personal choice and something you should check with your financial adviser. However, you asked specifically about a pick where you are already heavily invested. In order for my system to work on picks that have fallen, you need to be able to ride down with it to lower your average purchase price. So, make sure you have enough reserves to do so. It greatly increases your chance of winning.
Q: I have been a subscriber to your site for a couple of months now. I was skeptical of your trading methodology at first, but after a couple of wins I am a believer. My question is: Do you ever give up on a pick and cut losses? -- Craig, Shelby, Mich. A: Craig, I never take any option off the table, as I think it's smart to always have choices. That said, I have not cut and run to date. Some of my picks have required me to stand tall when things looked pretty bleak. For instance, my Morgan Stanley ( MS - Get Report) pick fell quite a bit, and I had to average down a lot in order to grab a win. But I had plenty of time with Morgan. UnitedHealth ( UNH - Get Report) looked like it was left for dead before coming back. Of course, I repositioned myself by averaging down. Now, don't get me wrong, many of my picks are straight $1,000 winners, but as you note, some do require some intestinal fortitude. The one thing that can throw a curveball into the mix is time. When an option gets close to expiring, I may consider some alternatives -- one of which is rolling the pick over into another one further out. It is not something I have written about in my columns yet because none of my picks have gotten to that point. However, it is another tool I have in my arsenal. So, would I ever decide to cut a loss? I would never say never, but I haven't had to yet and don't plan on starting anytime soon. But I will always evaluate all options available to me and see what makes the most sense.
Always remember: Life is a journey, enjoy the ride! Lenny Dykstra manages the "Nails on the Numbers" newsletter service for TheStreet.com. One winning stock pick is enough to pay for an annual subscription to "Nails on the Numbers." (Click here for a free trial.)