Add-on Buy:(PWRD)

I made another purchase of (PWRD) today, which makes for a good topic as I actually bought more of the stock below my original purchase price, therefore by definition I averaged down. If you've been following my blog, you may have seen my rant about value investing which included my thoughts against averaging down. I think it's worth discussing why I decided to do it.

First the facts: I originally bought (PWRD) at 31.58 which was 5% past the buy point of $30.10 in a 10 week cup pattern. I've only been using my stock screener tool for a few months, and I was late to pick up on this group because of some of my criteria. I was filtering it out based on the weakness of the industry group, which I discussed at the time of my purchase of (SOHU).

At any rate, by the time I caught on to the Chinese Internet stocks, the five I liked had already all broken out. I picked up (SOHU) and (PWRD) each 5% past the buy point - which is acceptable.

In the ideal situation, however, I would want to make my first purchase at the buy point, add on more shares when the stock increased 2.5%, and again when it increased 5% from the buy point. Each add-on purchase would be for a lower dollar amount than the prior purchase. This is called pyramiding, and a number of great traders have used the technique (Livermore, Darvas, O'Neil to name a few). Let's say that I want to eventually own $10,000 worth of a stock with a buy point of $100; my first purchase would 50 shares at $100, then another 30 shares at $102.50, and finally 20 shares at $105 - of course it rarely works out that neatly.

Instead, I found myself buying at the high end of the safe range - therefore I bought my half position and resolved that I would have to wait for a pullback or a new base to add more shares. There are a number of chart formations that can signal a safe point to add shares. However, all of these happen at a higher price than the original purchase.

I added on today as (PWRD) pulled back to $30.85, 2.5% above the buy point. To some of you it may seem like it's not worth all this discussion - either way I buy the stock at $30.85 - what difference does it make if it's more or less than the previous purchase?

Fair question, and one I considered before buying. The quick answer is, I almost never want to buy a stock when it's moving against me. No matter whether a buy point forms with a pullback to a moving average or a base, the time to buy is when the stock moves up on big volume past a buy point formed by the pullback or base. I want to buy when the stock is moving up.

However... sometimes a good stock will breakout and then retreat into buying range again. In this case, it is possible to consider this a second chance to purchase the stock if I missed the initial breakout. Still, I would typically not want to do this if I already own the stock, as now I'm averaging down.

This is where the waters get a bit muddy. Whether or not I already own a stock clearly has no bearing on the potential success of a new purchase. The stock doesn't know that I own it (if it did, it would probably go to zero immediately). I believe the rule exists to manage the investor's psyche. It takes a great deal of discipline to invest successfully, and if I get into making new buys of a stock that is already moving against me, it sets me up to get emotional about the situation. Let's say it corrects a little further, I may not want to admit I was wrong twice and may even be tempted to add-on again. Ludicrous as it sounds, the market can drive an investor to do such things.

Having said all of this, why did I do it? Discipline and patience have been lacking in my investing, which is a good part of the reason I started this blog. I second-guess decisions like the one I made today, and try to determine if it was a shrewd move or an unnecessary risk. There is a strong argument for the latter.

What I liked was that the stock pulled back in lighter volume than the past four days when it moved higher. That's a healthy break for a stock that has increased 15% in four days. I also liked that it didn't drop to the buy point - it went as low as $30.20 and then came right back up to the $30.85 area. I like that the group is breaking out one stock after another, and I think there is an excellent chance that (PWRD) will be the next to fire off. I wanted to increase my holdings in this group, and (PWRD) gave me a chance to do so.

I could say that time will tell if it was a wise decision, and that's true but not in the way it sounds. If I make money on (PWRD) that doesn't mean I was right to make the buy today. Trading stocks is about swinging the odds as much in my favor as possible, and time and experience will tell me if this kind of a buy hurts my odds or not.

I think that's what I love most about investing. I can read and study hours a day (and I try to do that), but in the end there is no substitute for experience. I don't know what a bear market 'feels' like until I live through one. I don't know about the beginning of a bull market until I live it. If I do this for the next 30 years, something new will still come along every week.

-Geoff