The Prudent Investor


Buying Methodology, Part 1
March 6, 2007, 8:13 am
Filed under: Update

I wrote about blind investing long ago, and it’s time to bring the subject back up again. There are two types of blind investing, one that makes sense to me and the other that does not. I’ll start with the latter.

Perhaps “blind blind” would be the best way to characterize the type I am not fond of. In this scenario, one acts a particular way regardless of the circumstances. I think that this methodology was a contributor to the crash (if I may be slightly dramatic) on 27 February. As I write this, nobody has a firm answer as to the cause of the big decline. The reasons are varied – China, the submortgage market, and numerous other possibilities are mentioned – I would be inclined to believe that each had its part to play. However, I also think that blind blind investing may have also been part of the problem.

An example of blind blind investing is when one sets a stop on a position – sell the equity if the price drops to a predetermined value. The idea is that if the stock’s price falls to a certain level, regardless of reason, then it will be sold to prevent a further loss. Of course, what often happens is that stocks that take very short dips end up getting sold during the dip, so the investor has then sold at the low point. I would not be surprised to find that after the Market started falling on the 27th, computer programs looking to react to this began selling, which made for lower prices, which in turn made for more selling. I would be willing to bet a week’s pay that this was a major reason for the DOW dropping over 200 points literally within minutes on the afternoon of that day.

In my mind, this “blind blind” way of doing things just is not a good idea.

The other kind of blind investing, which I’ll refer to as “blind aware,” is quite different. It recognizes that trying to time things can be not only frustrating, but downright impossible. I tested this with the knowledgeable investors at The Motley Fool about seven years ago. Intel had taken a big plunge on a Friday, so I sent a message asking people if they were going to take immediate advantage of the downturn. All responses, with the exception of one, indicated that Monday morning they would be buying heavily. By the end of that following week Intel had continued to plummet (and did so for the next few months). The overwhelming consensus was completely wrong.

Indeed, the first purchase of SJW took advantage of a major drop in the stock’s price, and it has continued to fall. The saving grace here is that the intention is to make multiple purchases over time, and this is where the “blind aware” part comes in.

It is my intention to purchase six companies for the portfolio, initially funding each position with about $500, and making $100 worth of purchases during each month. At this point I only own a single company, so the description as to how I will decide to invest when more than one company is in the portfolio will come at a later time. For now, I will use a methodology called INVEST%, which was introduced to me long ago by MoneyPaper.com. I will explain how this works in my next post.

Advertisements

Leave a Comment so far
Leave a comment



Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s



%d bloggers like this: