Importance of entring a stock and when to sell

Importance of entries and the dynamic of adding to positions on a pullback. He understood the importance of the entry price, but he wanted to understand why the entry price was so critical, especially since subsequent additions to the initial position would be at higher levels than the original position. It is an interesting question that cuts to the heart of the role emotions play in risk management. Think about it. Let's say you have a small long position on a stock that has moved up in price. It begins to pull back, yet instead of selling your position, you add to it. That's fine, but why is this different than simply buying a stock that you like at any given price level? If it moves up, great! You'll buy more on any subsequent pullbacks. If it moves down, you just buy more on the pullback itself rather than stop yourself out. Understand the scenario? Why do we use more discipline on the initial entry than on subsequent additions to the position? I think the answer revolves around the impact that emotions have on our trading decisions. Initial entries are important because they are the toughest part of the trade. The greatest amount of uncertainty, and risk, comes when we first buy a stock. Because if we are wrong, we aren't giving back part of the profit, we're giving away some of our risk capital. This is why we are the most vulnerable to emotional trading at that time. The margin for error is small. This is why it is important to enter as closely as possible to the level which, if hit, informs us that we are wrong about the trade. We can make a quick exit for a small loss and chalk it up as a cost of doing business. But what if the entry is poor -- being very high above any credible support level? That creates a dynamic that puts us at a disadvantage. By the time the stock falls to critical support, we may be so emotional about the initial drawdown that we can't think clearly. Instead, our actions are more likely to depend on what's happening with the other positions in our account. If we have been doing well, then our action in managing this one errant position is likely to be different than if we have been losing money. That goes against the discipline of judging each position on its own merits. Try being patient with your entries. It's fine to want to get involved, just get involved at a good price.

Position Sizing

Eric Wolff submits: Figuring out the right position size for a stock, and deciding when to sell and when to double down is probably one of the more difficult aspects of stock investing, and an area I find myself struggling with regularly. It is one of those areas of investing that I believe is a bit more of an art than a science

A lot of position sizing usually depends on an individual investor's risk tolerance and desire for diversification. I know several people who keep a very concentrated portfolio (as few as 2-10 stocks), and others with upwards of 30-50 positions. Each has its benefits, though I personally lean towards the more concentrated portfolio, as it is easier to keep track of, and allows for more $$ in places where you have the most conviction. I personally like to fall within about 15-20 for the long side of my portfolio, as it allows for a bit more diversification while still allowing me to heavily weight my top five holdings, which I usually like to have about 40-50% of my total portfolio. I don't like to have a position grow to more than about 15% of my total portfolio, unless there is a very strong margin of safety or unless I am unusually confident in the companies' prospects. In general, my largest holdings are ones I have the most confidence in, and those with the largest margin of safety (I will rarely, for example, invest 10% in a speculative stock).

Position sizing is a constantly evolving question. As information changes (the stock price, company prospects, etc.), the position should be re-evaluated to ensure exposure is consistent with the risk/reward of the stock. In the case of Mad Catz Interactive (MCZ), I originally started it off at as a 10% position. When the halo deal was announced and the stock shot up, I continued to hold the position, as my fair value of its upside potential was now more than when I bought. When the stock reached $1.40, it was beginning to near some of my more conservative valuations. I asked myself if I would buy the stock again if I did not own shares, and the answer was yes--but it seemed to me more fitting of a 5% position in light of my other holdings vs. the 15% holding it had become.

When To Sell

I think this is another area that can be a bit more of an art than a science. With certain investments, I usually have a catalyst in mind that I plan to sell around--for example, strong earnings in a particular quarter. With others, I plan to hold the stock indefinitely as it is a company I want to be invested in over the long haul [EYE.A and Meta Financial Group Inc. (CASH) are good examples].

I try as best I can to stay objective with my holdings, and always ask myself if I would still buy if I did not own it--particularly after big moves in the stock price or news that alters my investment thesis. Madacy is a great example of an investment in which I lost my shirt, but I believe I played well, all considering. The stock got whacked down about 60% after what appeared to be a one-time issue with their largest customer. Management bought back shares, and I decided to double my position, as I believed my thesis was still intact. Over the next couple quarters, however, it became clear that this was more than a one time issue, and that the operating business was significantly impaired. I recently closed the position at a loss.

Most important, I think it is useful to continue to evaluate what strategy works best for you and what doesn't, and to make decisions accordingly. There are rarely hard and fast rules in investing, and I think this is an area in particular where that is true.