Portfolio management is all about the risk you are comfortable taking on. If you can psychologically handle volatility, then a base of 5 to 10 stocks bought over time following my reports should be adequate. However, if you’re super risk adverse, a base of 30 stocks should be sufficient to give you plenty of diversification. Or, if you plan on investing incrementally as you have money, then just buying stocks as they come and holding them forever or until you have 50 positions isn’t a bad idea either.
That said, while there are definitely companies that turn into Apple, Amazon, Google, or Berkshire Hathaway, there are hundreds others that have shorter term gains based solely on an adjustment in price to value. For example, let’s say XYZ Inc. meets all the core tenets and has a historical earnings multiple of 15x, but for whatever reason, the market (aka traders, investors, etc.) has pushed that down to 10x. If the price is $30 and the company has $3/share in earnings, what happens if in 3 years, it grows to $4.00 with a normal 15x multiple? You get a 100% price gain.
As a rule, if you’re not outperforming the S&P 500 Index over a 5 or 10 year period, you should place the majority of your assets into an Index Fund, speculating on trades with far less capital. Again, there’s nothing wrong with trying to find the next Facebook or Priceline, but while you do it, make sure you’re building wealth with the market too.
Leveraging your cash positions to trade for short-term gains is something that great money managers like Warren Buffett, Joel Greenblatt have done. If it’s good enough for these gurus then it should be something you learn as well.
Writing Covered Calls
When you write (i.e. sell) a Covered Call Option, you give the right to someone else to take the stock away from you. This is beneficial when you already own a stock and want to make money while waiting for the price to reach a specific level.
For example, if you own XYZ at $10 and write a call at $12, you collect a premium from the contract. If the stock is called away at $12, you keep the premium and the $2 profit. If the stock doesn’t reach $12, you still keep the premium. Writing covered calls is a great way to exit positions when the stock price is relatively stable.
Writing Naked Puts
When you write (e.g. sell) a Put Option you provide the right for someone else to give you the stock. This is beneficial if you want to own a specific company’s shares at a specific price, but the stock is not yet trading at that price.
For example, if XYZ is trading at $10 and you want to own it at $7.50, you can write a put at $7.50 and collect a premium from the buyer who may be trying to protect his/her position in the stock. Naked put writing is a great way to buy into positions during volatile markets. Writing puts is a great way to get paid to wait for the right price in stocks you want to own.
Options are derivative contracts that allow buyers to control large blocks of the underlying asset with very little money – 100 to 1. If you’re right on a trade, you can see massive gains, like this hedge fund did. However, if you’re wrong, it can cost you a lot of money, either rolling over your position or taking a total loss. The buy side option trade should be with short-term conviction tied to massive volatility in one direction or the other.
Arbitrage arises from corporate activity. During a typical year, there are hundreds of corporate mergers taking place. It’s the nature of the business. In these trades, there is a specific price that is agreed upon by the parties before the buyer conducts due diligence. This price is rarely reached before the deal actually closes, leaving a percentage of profit to the investor. The risk with arbitrage is associated with the deal not closing.
Always keep up to date on events that surround the deals you trade. The rate of return will be different for each situation. For instance, if XYZ Corp. is paying a 25% premium for ABC Inc., and if the two companies are merging in 4 months, you will receive an annualized return of roughly 90% as long as you can put the money back to work in similar deals.
- Only trade stocks in companies that have already announced a merger deal. Never speculate as to the possibility of a merger.
- Stick to all cash deals in stocks with trading volumes above 50,000 if possible.
- Only buy when the rate of return is over 15% annualized.
Dollar Cost Averaging
If you’re buying companies that you think are going to be much more valuable long term, you will experience short term pain. Anytime you find that a company can produce above average investment performance based on thorough analysis, you should consider owning it, regardless of whether you already own it at a different price. I can’t tell you how many times I’ve been in a stock at $1x and it dropped to $0.60x only to get back to $3.00x. If it’s down and you believe in its long term prospects, buy more at the lower price using the same amount of capital you initially bought in with.
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