What do you do when a long-term stock position bites the dust? This is the question I want to explore today. It’s a dilemma that every trader faces. And it’s incredibly difficult to answer in the heat of the moment. Thus, as with all trade management questions, it’s one best addressed BEFORE the trial arrives.
To be clear, I’m assuming this is a stock we want to own for the long run (multiple years to decades). We like the long-term fundamentals and growth/income potential. And it could be a diversified ETF like SPY, IWM, and QQQ.
I’m going to use Verizon as an example. It’s giant in the telecom space known for its generous dividend and long-term stability. But, despite the S&P 500 sitting a stone’s throw from all-time highs, Verizon has fallen 20% from its peak. No doubt the severe relative weakness is testing shareholders’ convictions. I am one of them.
So what are our options?
Jump out and back in
New traders may fairly ask, “why not get out when VZ goes down and get back in when it starts going back up?” Isn’t that a legitimate way to handle the inevitable corrections and bear markets that arrive along the way?
The answer, in short, is no. Take a look at the past ten years of Verizon’s share price history and see if you can figure out a rule or signal that consistently got you out before a significant drop and got you back in before prices recovered.
It doesn’t exist. Not for Verizon, at least. The stock doesn’t play well enough with technical analysis.
I hasten to add that even if you could find a quality signal, it doesn’t guarantee that signal will continue to be effective. I don’t mind stop losses and quick exits for short-term positions, but long-term investments require a different approach.
Sell Covered Calls
If there’s enough premium available in the listed call options, you could sell calls to reduce the loss while the stock is trending lower. I’m a big advocate of this for long-term stock positions, provided you have good rules for management. Unfortunately for Verizon, the call premiums are too paltry to make it worthwhile. In other words, the tiny premiums received on the winning months will be dwarfed by the occasional loss when VZ leaps higher.
Buy Protection
This is a legitimate option, but the devil’s in the details. Many traders panic and buy puts at the wrong time. Or they buy them at the right time, but overstay their welcome and don’t end up capturing enough profits. It requires skill and a good plan to use them successfully. Personally, I prefer the next two ideas more.
Position Size Properly
If Verizon is a small enough position in my portfolio, such that I can handle any and all drawdowns, it really makes the question of handling downturns easy. I simply let the position ride. Remember, lower prices aren’t always a bad thing, particularly when you’re reinvesting dividends.
Verizon pays shareholders a cash income of 64 cents per share per quarter. That translates into $2.56 annually, for a yield of 5.09%. If you use the cash to buy more shares, then you should want lower prices. I can buy more VZ at $40 than I can at $60.
I consider the 5.09% as the reward for sticking around. It’s the incentive to stay the course and ride out the storm.
Dollar Cost Average
One of the most powerful ways to rapidly reduce your cost basis and accelerate how quickly you’ll recover is to buy more shares. This can only be done, mind you, if your position wasn’t too large to begin with. Otherwise, it’s irresponsible. In the case of Verizon, suppose we originally purchased 100 shares at $55 and the stock falls all the way to $45. If we purchased another 100 shares, it would reduce the cost basis (i.e., breakeven) to $50.
Obviously, you can’t keep adding shares indefinitely. At some point, you’ll be in a full position and increasing the share count further would be too risky.
In trying to decide when to buy more shares, I have two suggestions.
- First, the stock needs to have fallen far enough from your original purchase to move the needle with your second buy. In the Verizon example where the first buy was at $55, it wouldn’t make sense to add more shares at $53. The $2 drop is only 3.6% lower. Doubling your share count would only cut the average cost by half that amount, or 1.8%. I suggest waiting until the stock has dropped at least 10% lower than the original entry. You could increase this number for more volatile stocks.
- Second, use technical analysis and potential support zones to further fine tune your entry. If the stock drops 10% but just broke below major support and looks to be headed lower, then wait until it approaches the next floor before adding.
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One Reply to “Tales of a Technician: Handling a Losing Stock Investment”
Thanks Tyler – I needed this guideline.
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