Buy Rules and Position Sizing

I think the extended bear market had some negative effects on my trading in addition to some of the positive effects. I was realizing today that I've gotten a bit sloppy, maybe even lazy, in the way I've been trading. I decided on the way home from work that in addition to the Sell Rules I have posted here I need to post my Buy Rules as a constant reminder the proper way to do things.

One mistake I made recently was the purchase of (TNDM) about ten days before the company is set to release earnings news. There is no 'official' CAN SLIM rule against this, but I've read about it and believe it's good practice to leave a three week buffer between the purchase of any stock and their earnings release. Would this mean I'll miss some winners? Certainly so. The buy stop I cancelled Sunday night was for a stock that went up over 10% today. Rules are not about individual situations - they are made to put the odds in my favor. If, over time I see this rule doing more harm than good I will adjust it or discard it, but for now I'm adding it to my system.

I guess I should mention the theory behind the rule. Buying a stock within three weeks of earnings news doesn't leave much time for the stock price to advance and provide some kind of cushion. Therefore, if the earning news is disliked and the stock tanks, I would be left vulnerable to a huge, even catastrophic loss. Better off to wait and if the stock is a real winner, another buying opportunity will present itself.

Another rule that I followed recently and want to document is 'buy strength, not weakness.' I'm proud that I did this on Monday when (TNDM) stopped out for a loss. Instead of getting attached to it and buying it back (trying to prove I was right about it), I channeled my capital into the stock that was working for me, (ARST). Buying strength doesn't just mean adding to stocks that are working, but also never adding onto a stock that is going against me. I must never make an addon buy at a lower price than my initial purchase - this will almost always end badly.

Next, on to position sizing. This was another lazy mistake I made recently, and a fine example how easily emotions can creep into trading without me even recognizing it. When I came off my three weeks in the penalty box, I purchase (ARST) and then a couple of days later (TNDM). I 'liked' (ARST) and I 'loved' (TNDM), so without giving it any thought, I had purchased a smaller initial position of (ARST) and a larger initial position of (TNDM). This is flawed for several reasons.

For one thing, if I'm not confident in the purchase of a stock, I shouldn't buy it in the first place. I don't think that I should have varying expectations for different purchases. I should either like the stock enough to buy it, or not. It can look like it has the right stuff, or not. There is no in between. Market conditions may dictate smaller pilot buys, but these should be equal for any stock purchased within a range of time.

Given that I believe a stock is worth buying, it makes absolutely no sense why I would purchase more of one than another. That would only be the right course if I knew which stock was going to succeed, which of course I don't and if I didn't, wouldn't buy the other at all! The math only works on a trading system if I treat all positions equally, and that requires a plan for position sizing. I'm going to add that to my blog tonight as well, and I'll detail it here.

Due to the small size of my portfolio, I will own a maximum of two stocks. As it grows (thinking optimistically) I will adjust this as necessary.

The first purchase in a stock will be with 33% of my capital as close to the pivot point as possible. I use buy stop orders with contingent stop loss orders at 5% below the purchase price. If the position is working, I can add on to it from 3-5% above the pivot point with 16% of my capital. Same numbers hold if I add a second stock to my portfolio.

If a stock and the market are working very well, I can consider purchasing at a secondary buy point (pullback to the 50 day moving average) on margin - but this would be evaluated very carefully and with a tight stop.