Page 422 - THE MARKET WHISPERER
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418 PART 11 - Risk Management
wait a little and it goes up by two cents. I buy at $2.02.
Do you see what happened here? My decision to buy or not was based
on the price moving up by one or two cents, rather than on percentages.
My consideration in both cases was that the price is reasonable, and
relatively close to the price I initially wanted to pay. But note the difference
in percentages: for the $20.02 share, I bought at 1/10 of a percentage
above the planned price, whereas for the $2.02 share, I bought at 1% of
the planned price.
The principle is simple: people buy stocks according to their movement
in cents, not in percentages. Because of this standard human behavior, a
good breakout for a share at $20 will be approximately 20 cents, and a
good breakout for a share costing $2 will also be around 20 cents. So how
does this tie in to fixed quantities? Where does the problem lie?
If I were to insist on buying stocks according to a fixed sum of money,
let’s say $10,000 per stock, I would then be buying 500 of a $20 stock or
5000 of a $2 stock. If both break out at 20 cents, and breakouts can occur
within seconds, then I have made $100 on the $20 stock, and $1000 on the
$2 stock. Cool, right? No, not cool at all. Remember: the potential for profit
equals the potential for loss. Within seconds, before you have time to say
“there goes my account…” the $2 stock can just as easily move 20 cents
against you and wipe $1000 out of your account.
SMART Traders naturally tend to buy stocks according to their
MONEY movement in cents rather than percentages. A successful
breakout for shares priced at $20 will be 20 cents, just as it
will be for shares priced at $2.
Summary
Be disciplined about buying according to quantity rather than sum of
money. If you are comfortable with buying in multiples of 500 shares, then
do that always, irrelevant of the share price. The exceptions to this norm
are for shares at $70 and up, or small caps with clear, very low volatility.
Remember that every stock has its own “personality.” Therefore, a good
rule of thumb is to always buy a fixed quantity. Before clicking the buy
button, just check the stock’s volatility thoroughly and take your decision
on whether to increase or decrease the quantity.
